Stocks pulled out of a stunning tailspin last week by mounting a ferocious rally in the last two days that actually occurred faster than it might have seemed: The S&P 500 gained 122 points, or 11%, in just 3 hours and 10 minutes: 1 pm to 4 pm on Thursday and the first ten minutes on Friday. (The last 6 hours and 20 minutes on Friday were flat.)
That kind of move might not be uncommon for a single stock. But for the entire market of 6,000 securities? It’s virtually unheard of.
Putting aside all the economics and politics, let’s look at the market from a technical point of view. In other words, if we didn’t know anything about the news, what is the message of the market itself?
You may recall that that in the middle of last week I said we had to be on high alert for an upside reversal. The reason: The market had just experienced a series of four 90% downside days in a tight, 20-day span. Although it’s a bit scary to live through moments like those, we have a lot of market data to study, and history suggested that after such an intense cluster of panic selling, a 90% upside day was likely to follow soon. (See also: "Super Intense Stock Plunge May Bring Opportunity.")
And sure enough, it came on Thursday: the first 90% Upside Day to come immediately after a 90% downside day. That is really good news—it means that we can say with some assurance that a tradeable rally has begun! And though the market was up 10% from its lows by Friday’s close, there should be plenty of profitable trading ahead. We kind of need to put aside our intellectualizing of the whole thing—i.e., we need to forget the rally was artificially induced by the short-selling ban—and just scale into the market to take advantage of what could be a sizeable move.
From now on, I will report regularly on whether we’re seeing the short squeeze materialize into vigorous demand for a wide variety of stocks—the key element that separates a short-term rally from a new bull market. If the quality of the rally begins to fade, I’ll be able tell and let you know. But for now, purely in your role as an investor, as the old Bobby McFerrin song suggested, don’t worry—be happy.
Socialized Finance
Who would have thought we’d have socialized finance in this country before we have socialized medicine? No matter how much the banks have screwed things up, one can only imagine it would be worse if government were in charge. If you think about it, they’re planning to move from a completely laissez-faire attitude toward regulation to total domination.
Until Congress pushes back, however, we’ll have to live with it, I guess. And the main thing that is likely to happen next is that the Feds will have to pay for all this by selling Treasuries on an unprecedented scale. This will lower the price of Treasuries even below the ridiculously low levels we see currently, and essentially force people into stocks and corporate bonds.
As a result, in the short term, I believe we’re going to see a worldwide stock-market rally as investors applaud the authorities for trying to refloat the banks and evaporate their losses. The nuances that the public will be paying for Wall Street’s excesses will be debated on talk shows, but in the trading pits we’re probably going to see a relief rally that focuses first on pushing up the value of the most "damaged goods," or stocks that have been the most badly beaten down up to now: banks and commodity producers. (See also: "How to Profit From the Market Meltdown.")
However, I don’t think this rally will last too long. Turning our attention away from the stock market, the real economy is not actually much helped by these programs. All the money that’s being generated from the bond sales will go to fill up holes left by losses—not to building factories and creating jobs. Money that could have gone into research and development, infrastructure, schools and universal medical care will instead go to make up for bankers’ and borrowers’ mistakes.
If the government buys back bad loans from banks at their current value, not the value on which they’re being carried on books, hundreds of banks will be faced with massive losses and will be closed. And as for Wall Street investment banks, the future is likely not too bright either. If derivatives can no longer be created and sold at high prices to wary overseas investors, then you can bet that half the people at companies like Goldman Sachs (GS) and Morgan Stanley (MS) will be laid off. This will have broader implications, as he financial industry is the biggest buyer of technology—so the decline in jobs and merger of back-office operations will likely depress tech companies’ profits for several quarters, if not a year or more.
Moreover as bank balance sheets are recapitalized, the credit crunch that is currently forcing U.S. manufacturing plants to close left and right will intensify. And it won’t take long for Wall Street to recognize that the recession which started earlier this year will likely continue well into next year even if the new presidential administration attempts to launch a big consumer stimulus package on top of everything else.
My estimate at this point is that the rally will push up to the 1,330 to 1,365 area of the S&P 500, which form the 200-day and 12-month moving averages over the next three to six weeks. It would probably happen in fits and starts that may include a retest of the recent low. Ultimately, that would be move of around 8% to 10% from the current level.
That would retrace a lot of the recent panic lows, but then we will be faced with a recession that just won’t quit on the government’s cue. History says that stock markets typically bottom halfway through recessions, so to bet on last week having amounted to a low is a bet that the recession will end in the first quarter of next year. Much as I would love for it to be true, I’m dubious. As a result, it’s quite possible that the market will ultimately go to new lows after the exciting financial crisis morphs and deteriorates into a boring, grinding, run-of-the-mill economic slowdown. Subscribe to my Trader’s Advantage newsletter to learn what to buy to take advantage of these moves. Click here to learn more.
Jon Markman is editor of Trader’s Advantage and a regular contributor to InvestorPlace.com. To get this type of actionable insight from Jon and other InvestorPlace Media experts go to www.InvestorPlace.com today!
