Don’t Get Sucker-Punched by This Rally

by Dan Burrows | June 7, 2012 12:57 pm

Take the best day of the year for the Dow Industrials followed by an early triple-digit gain Thursday, and suddenly the blue-chip index tacked on more than 400 points. It’s the sort of burst that can have defensive-minded investors[1] questioning not only their strategy, but their sanity[2].

But at times like this it’s best to remember that one or two sessions does not make a trend. Traders — not investors — move the market on a day-to-day basis. So while some headlines and some technicals came to the market’s rescue mid-week, there are still plenty of ways stocks could get whacked in the weeks and months ahead.

On a technical basis[3], the market was due for a snapback, anyway. Deeply oversold conditions, negative sentiment (a contrarian indicator) and the case that the break below the 200-day moving average didn’t stick helped entice traders to bid.

Headlines were mostly accommodating, too. Yes, the European Central Bank failed to cut rates, but rumors are percolating that the Continent’s powers-that-be are working on a scheme to bail out Spanish banks. Meanwhile, hope springs eternal that the Federal Reserve Board will extend Operation Twist or unleash a third round of quantitative easing[4] when it meets in less than two weeks. Chairman Ben Bernanke’s comments[5] before a congressional panel today provided new clues, however, as whether or when such actions might occur.

A decent bond auction on the part of Spain and China’s surprise rate cut — its first in four years — added to the market’s rosy glow on Thursday.

But as JP Morgan Chase strategists point out in new research, formidable risks to the global economy and markets remain. Among the biggest threats they outline:

In another alarming reading of the economic tea leaves, China’s first rate cut since 2008, while welcomed by the markets, could actually signal that something very bad is coming. As strategists at Citigroup told clients Thursday: “There has been much discussion this morning about what the surprise China cut portends for the slew of economic data (industrial production, fixed asset investment, retail sales, and trade balance) scheduled to be released this weekend.”

The fear is that China cut rates because the weekend figures will be weak and, more worrisome, that Chinese monetary policy is well behind the curve.

In other words, when it comes to easing, be careful what you wish for.

Low summer trading volume makes the market especially sensitive to the latest data points and headlines. What it gives on the upside it can just as quickly take away (recall last Friday’s stomach-churning dive). So remember: There’s nothing wrong with staying defensive[7] through the recent upswing — and longer. The sell-off could easily resume as early as Monday if China’s weekend data dump disappoints — or if Europe produces more financial drama.

Oh, and the Greek election is still 10 days away.

Getting out of June will be stressful enough. Summer has a long way to go.

  1. defensive-minded investors:
  2. their sanity:
  3. On a technical basis:
  4. extend Operation Twist or unleash a third round of quantitative easing:
  5. Chairman Ben Bernanke’s comments:
  6. eurozone remains a huge concern:
  7. staying defensive:

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