Stocks clocked in Thursday with some magnificent action, advancing 1% at the open, then sinking by 4% midday before reversing on strong volume to finish up 6.5%. Oh, doctor!
Normally I would wisecrack here, maybe suggesting that traders really need a dose of Dramamine before showing up to work these days. But I think that there’s a pretty good chance that the Thursday action was too meaningful to mock.
Some terrific elements lined up in trading today that actually make me hopeful that U.S. stocks put in a meaningful intermediate-term bottom at last.
I can hardly believe I’m saying this, but it might finally be time to get that long-awaited retracement back to the 12-month average that has been delayed so very long. Even if it’s just another bear-market rally, that would amount to a 35% rally from the Thursday close—something you just would not want to miss.
A few technical things made today’s move unusual: It came on bad news, it came on volume, it came on strong breadth, it was led by the right groups, it amounted to a "key reversal" and it came when few people, myself included, thought it could arrive.
And perhaps most importantly, it followed a classic "false downside breakout" pattern, which is a decline that takes an index or stock below a major prior low and then reverses sharply to finish much higher.
The move higher after 1 pm ET was one of the most stunning three-hour advances ever recorded, according to my data, and it occurred in a steadfast, soldierly fashion, as if a city block full of computers clicked off one programmed trade after another and marched stocks forward in a line.
If you weren’t paying attention, here’s the quick summary…
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We saw a 1,450-point move in a single day: 150 up, 450 down from the first top, then 850 up from the bottom. That is a more than a typical year’s total action in a single six and a half hour span. It was breathtaking even by recent standards, and if it caught you by surprise, trust me, you were not alone.
The Dow ended up 6.7% to 8,835, the Nasdaq was up 6.5% to finish at 1,596 and the S&P 500 was up 7% to close at 911. Leading sectors were real estate investment trusts (weren’t they massive laggards just yesterday?), coal, steel and paper, while laggards were defensive groups like health care. Advancers strongly outpaced decliners by 2,305 to 810 on the New York Stock Exchange, though because of the push down at noon, new lows far outpaced new highs by 685 to 9 at the NYSE. Upside volume appears, at first count, to have amounted to 89% of total volume, which is good.
We always say that the market moves in ways that will surprise and wrong-foot the majority, and if you look at the mutual fund figures you can certainly see that today’s action may fall into that category. TrimTabs reports that the week ending Wednesday saw an outflow of $32 billion, reversing an inflow of $2.2 billion the prior week. U.S. equity funds made up $21.3 billion of that total.
Meanwhile, $6.3 billion also flowed out of bond funds, vs. an inflow of $518 the prior week. There are going to be some big regretters in the world if the markets start to move higher next week, and they will provide some fuel for the move if it comes.
So what happened?
Well, picking up on my lead paragraph from last night, the Dow just didn’t like what it saw when it peered into the abyss. Those pixies appeared, the magic hand, the value investors, the cavalry—call it what you will. I think it was mighty coincidental that this was the day that four major hedge fund managers appeared before Congress to answer charges that they were terrible people and that their industry had ruined the investment universe.
Is it possible, just maybe, that their trading desks coordinated this move to take the heat off their bosses? Naah, couldn’t be…
But just to throw a little more gasoline on this fire…
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…I will note that a lot of hedge funds, including at least two whose chiefs appeared before Congress—Harbinger and Citadel—are down a lot this year, and could really use a late-innings rally to get back at least to even for 2008 and ensure their staffs receive bonuses.
Regardless of whether the action was independently determined or coordinated, the fact is that the October 10 and October 27 lows were finally fully tested and found firm. And that is a fantastic start for the prospects of a retracement. The only question now is the usual one: Will there be any follow through, and what will be the quality of that follow-through if it occurs?
Before we get too carried away, indeed, let’s remember that there have been two two-day rallies of 1,000 points or more for the Dow Jones Industrials (October 13-14 and October 28-29) that ultimately proved meaningless. If we get another low-volume, weak-breadth advance next week like the last two times similar surges occurred, then today meant absolutely nothing.
Next on the Horizon
What we need to see is strong demand from value buyers sweeping in to buy bargains of the decade, and we need to see sellers stepping aside just as they did in the afternoon today.
One point in bull’s favor, in fact, is that this is the last day that many hedge funds will allow redemptions before the end of the year. So even if there is not much new buying demand, we could see a big advance simply because sellers have retreated to the sidelines.
The ideal action now would be a 68.1% Fibonacci retracement of the move from the 2007 high to the Thursday low. That would coincidentally put the S&P 500 right at its 12-month average, where we have long suggested it would go just in the course of normal market action.
You can see that the CBOE Volatility Index ($VIX), shown above, is trying to cooperate with this concept by coming down off its ledge. It’s now down under its 50-day Bollinger Band, and the next positive step would be a decline under 50, and then 40.
If all of this transpires as described, my assumption is that it would still turn out to be just another bear-market rally, and then stocks would head back down next year to the Thursday low and beyond as a prolonged recession is discounted. Credit continues to trade very poorly, likely forecasting many bankruptcies ahead. But that is getting at least two steps ahead.
The typical move for this environment now would be a modest setback on Friday, and then a resumption of the trade higher on Monday, perhaps punctuated with something positive like a merger between two large companies, as companies take advantage of low interest rates and all of the money that is being flooded into the system by the Federal Reserve, the Treasury, and the Chinese, Japanese and European central banks.
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This article was written by Jon Markman, contributor to InvestorPlace Media. For more actionable insights like this, visit www.InvestorPlace.com.
