March Rally: Fleeting or Sustainable?

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 |  Includes: DIA, QQQ, SPY
by: Sean Hannon

With two trading days left in March, now is an excellent time to assess the market's performance. Entering the month, the S&P 500 had delivered a mixed message. Over two months, the index was 0.9% lower, but had rallied an impressive 4.6% from the low reached on February 8. As my timing model stood at an overbought 80% long, it was difficult to determine what future strength would push prices higher.

Digging deeper into the market internals offered little further evidence. Of the 37 trading days that had occurred, 21 saw higher closes (57%). With earnings season concluding and the economic calendar relatively light, we faced an information vacuum. With a lack of identifiable catalysts and a market that had bobbed and weaved all year, it appeared that 2010 was shaping up to be the range-bound, frustrating year most forecasters had predicted.

It did not take long to shatter this illusion. March started with five consecutive positive days and the S&P 500 finished higher 11 of the first 13 days. Considering that the two negative closes totaled a loss of 0.45 points, the market appeared as if it would never decline.

Looking backward, March has been a spectacular month. As an overbought market became even more overbought, the S&P 500 has finished higher 14 of 20 days (70%), is now 4.6% higher on the year and sits just 1.2% below the intra-day high of 1,180 reached this past Thursday. Anyone who thought an overbought market could deliver such impressive results, please step forward.

As impressive as the rally has been, the backdrop in which it occurred is startling. Generally, there has been a dearth of positive information. The economic and earnings calendars have been light and the headline grabbing news centers around Greece needing a bailout, Congress passing expensive health care legislation that will raise taxes, and the Federal Reserve (Fed) expressing its need to shrink its balance sheet and stop supporting asset markets. With prices rising despite such a negative backdrop, the key question is whether this rally is driven by momentum chasing investors who are buying in anticipation of a robust economic recovery and will quickly sell when news is released or the groundwork for a strong, sustainable move higher.

With the calendar switching from March to April, we will quickly receive an answer to this question. The first quarter ends Tuesday and companies will begin reporting their results over coming weeks. However, we will not need to wait until then. As detailed in EPIC Insights, the upcoming week of 3/29 to 4/2 is jammed with information that has the ability to dramatically swing prices. Now focusing on known catalysts, the market will receive a true test of the rally's sustainability.