Random Thoughts About a Potential Rally

There is a lot of talk these days about a bottom and we are certainly in the spirit with a seasonally strong period. I would argue that price action is looking a lot better, and charts are starting to build bases...from which we could see higher levels. Friday was a key 'hold' day at the 818 level for the SPX. This number was tested two other times last week and held stiff, so that is the line in the sand, with the VIX at the 66 or so level each time around. Sure the market has rallied 20% or so off the low, and perhaps some type of corrective action is in order. We'll be watching and looking for entry points. Some other things to think about are below.

Let's Not Forget - It's Still a BEAR Market

Resistance. It's the levels above current price where investors and traders say 'get me out, I'm back to breakeven'. Well, it's all over the charts and with higher volume to boot. Simply put, as price levels are achieved sellers are going to come out and dump stock, increasing supply and putting a damper on price. That's ok, but likely puts stocks in a range if buyers come in and pick them up. Good for the long term, bad for the short term as the market remains choppy. Regardless of your opinion about hitting 'bottom', this is not a good trend for option traders. I like to see momentum swings with moves in volatility. Stocks have been beaten down severely, so maybe there is a pulse.

Dropping Volatility and Reflating the Economy

Volatility has certainly been on the minds of investors and traders, and since August we've seen a big surge in this indicator. I think the push here is related to the uncertainty about our financial system and breakdown in our economy, and while the market always 'gets it right', this time it once again discounted the future.

I'm not sure what all this talk about quantitative easing is all about. I don't have a PhD but I suppose it's some form of help from the Fed. It seems that reflating the economy, adding more dollars into the system along with spending those dollars quickly allows for prices to rise much more quickly.

Note how this had an effect yesterday with commodity stocks, up sharply across the board when President-elect Obama announced spending on infrastructure, and China last week talked about increased stimulus via the same. Spending helps increase prices and margins for companies in steel, copper and others. All this helps ease our fears about the future as we see a continued drop in volatility.

Bases vs. Bottoms, Breakouts vs. Fakeouts

Make no mistake, today's bear market is one of the worst of all time. Accounts have been obliterated nearly overnight and it will take much time for repair. The elusive bottom is something talked about but rarely captured in terms of space and time. However, we can pretty much be convinced by seeing bases built that at least a temporary bottom is in. The price action tells us that stocks won't go lower, but of course they may not go higher. Watching volume levels at these times will also tell us whether institutional participation is at hand. Breakouts are more likely to occur when the supply of stock is eliminated. Right now, too much overhead supply exists for an extended rise, but I would imagine the fakeouts will be fewer...but only time will tell.

Disclosures: no positions

Comments

[herbert hoover:]

Stocks are trading because they look cheap based on historical PEs. That world is over. The next couple of quarters' earning will be brutal and PE ratios will rise, making these "bargains" look overpriced. Expect to revisit the lows

2008 Dec 09 09:04 AM

[axelrod608:]

Writing off losses hits the asset base, but when those assets were also interest or dividend payers, it also hits earnings. earnings in the financial sector should really stink for the foreseeable future.

Consumer spending supports 70% of the total economy and with layoffs running at a rate of millions per year, expect conumer spending to continue to contract.

Not much is left of our manufacturing sector. There's a handful of well capitalized companies, but most are carrying debt loads that will be hard to service with reduced earnings.

Commodities will rebound after being grossly oversold for liquidity reasons.

I fail to see the basis for optimism. The economy we brought into the 21st century was and is unsustainable. The biggest hurdle we face at this point is informing our "leaders" of the true meaning of unsustainability. So far, they're all using 20th century logic and tools to deal with a very different problem.

2008 Dec 09 09:38 AM

[Roger Knights:]

Good comments, you two.

2008 Dec 09 10:11 AM

[robert.b.fe...:]

Things are still doom and gloom. Housing may or may not have bottomed as the sector seems flat. Can't see an upside until mid February at the earliest.

2008 Dec 09 10:29 AM

[Kevin Walmsley:]

Good article. A client of mine phoned me last Friday and wanted to know why the market was rallying in the face of such dismal news. He knows I've been bearish for most of this year, and wanted to know if it was time to go long again.
Sure, I said. Nothing like the worst employment report since I was 7 years old to make me feel all bullish all over. And it's just beginning, I reminded him. The posters above are right, as we cynics usually are. With climbing unemployment and falling incomes, good luck convincing folks that expensive gadgets are a good gift ideas for this year. Or next.

2008 Dec 09 11:05 AM

[CLH:]

There are few sellers left so the volume will be low but we should slowly climb up as more and more investors crawl out from under the bed.

2008 Dec 09 10:10 PM

[happysoul77777:]

The mark-to-market accounting rule caused the implosion in bank capital in the last two months. Now, it's about the give banks more capital as bond prices hit new highs.

Watch the AGG. It has recovered almost to the pre-Lehman level. Banks now also have rougly 25% more in capital with the recent money injection by the Treasury.

2008 Dec 10 12:23 AM