The Market Rally Has Legs

“I dread looking at Wall Street tomorrow. It’s not going to be a pleasant sight.”

-- Senator Harry Reid commenting on the failed auto bailout bill.

Either Senator Reid was short going into Friday morning or he is a terrible market analyst. Despite his prognostications, the market did very well for itself, demonstrating that this rally does indeed have staying power. Several weeks ago I wrote the indexes made the case that a bottom may have been put in place. While the coast is not clear yet, overall the picture is improving nicely. So, what are the reasons for a continued positive market outlook?

The market is reacting positively to bad news. On December 5, the unemployment numbers were abysmal. Prior to the opening, everyone (except the contrarians) was ready for “Black Friday.” Instead, after an initial sell-off, the market chugged back and made gains. This past Friday, there were plenty of reasons for a decline: the failed bailout, the Madoff Ponzi scheme, et al. While starting down, the market eventually turned up for modest gains. Typically, when the market reacts positively to bad news, one can expect the trend upwards to continue.

Stock market leadership does not consist of defensive stocks or energy-related companies. The last few counter trend rallies that occurred this year were led by consumer staples or companies benefiting from high oil prices (oil-related companies and alternative energy stocks). Market leaders are beginning to emerge from areas such as infrastructure stocks (based on President-Elect Obama’s call for public works) to cutting edge biotech stocks (such as Emergent Bio Systems (EBS)).

Volatility has continued to decrease. From an intraday high of 90 in October to its present close at 54, volatility is slowly leaving the market. While this is well above levels to which traders are accustomed, the continued decline is heartening.

Chart-wise, on Friday, indexes successfully tested key support areas (85 area on the SPY and 28.50 area on the QQQQ). Moreover, no massive high volume sell-offs have occurred. Declines have occurred on lighter than normal volume.

One obstacle that needs to be surmounted is the 50 day moving average. Looking at the charts, one can see that as the moving average trends down, the index prices move right along with it. At this point, traders are showing a reluctance to cross that line. Once it is breached on good volume, it will be a good hint that the market rally will continue. We should know soon as the ranges on the indexes have been decreasing. So, the market will be forced to break to the upside or downside.

While I am not about to bet my monocle or my tony top hat on an extended rally, things are starting to improve.

Disclosure: No positions held in any stocks.

Comments

[investor88:]

Good comments but note "no positions" which means no strong conviction of a rocket rally. There is still risk after all! Having said that the market may confound and rally to 11k before pausing for direction!

2008 Dec 14 08:10 AM

[herbert hoover:]

Talk about irrational exhuberance. The markets' insane reaction to the bad news is a golden gift to get out at a much higher price than you'll see for some time. The unemployment rates are rising, foreclosure are building (remember the 3 month moratorium put in place in October?) retail sales are dismal, Corporate profits are negative. By June - if stock prices stay where they are - their P/Es will be in the mid 20s to low 30s. Buy high, Sell low.

The markets may have put in their lows for 2008. We will look back at them next year with envy.

2008 Dec 14 08:39 AM

[jepittman:]

You can add extremely negative investor sentiment of despair to the list. It is the polar opposite to the euphoria expressed at bull market tops. There, no one is bearish and the good news is everywhere - yet no one believes the bears. Ask yourself 'who got the big returns?'.

2008 Dec 14 09:01 AM

[Talenti:]

Thats just not true. This article is ignoring one VERY important piece of information. The only reason the market reversed its downward movement was because the White House made an announcement that it would step in and back the auto companies. Senator Reid was basically right at the time he made that comment. Market Rally my A@#!!

2008 Dec 14 11:46 AM

[happysoul77777:]

The market may be looking at the improving housing market and the new loan originations that are happening in the banking system.

2008 Dec 14 02:43 PM

[Kingsley An...:]

Mr. Hoover,
First, let me say I had the chance to stay in one of your fine establishments; I believe it was called Hooverville. Anyway, you indeed have a fair point. As indicated by my disclosure, I do not have any positions, long or short, at this time. Although I'm cautiously bullish, I have not bought into this this being the beginning of the next bull market. I have my fingers burnt to many times in the past to jump in just yet. Possibly a decent counter trend rally is under way- but time will tell and I will adjust accordingly. If you are a value investor (which I am not), the prospects may be more frightening. But when I do enter the market, I will most certainly exercise risk management to the nth degree, and I encourage others to do likewise.

2008 Dec 14 03:00 PM