Why I Expect a Bounce, and Plan to Sell

| About: SPDR S&P (SPY)

The long awaited bounce occurred on Thursday. With the Dow being down some 350 points intra-day, we recovered all that to close down a mere 15. The S&P 500 and the Russell 2000 were up. Perhaps more importantly, the financials rose.

The question now is whether this is the bottom or an oversold bounce to be sold.

Here is the action in the S&P 500 over the past 30 days.

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SPX Chart

As we see in the candlestick chart, Thursday was an intra-day reversal that ended positive. There was a similar day last Friday, although the selling was less intense. As we know, the market proceeded to sell-off hard this week.

In March, we had a similar event.

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SPX March Chart

From the March 14 low, the market was down very hard only to reverse intra-day. The market then ran from 1362 to 1555, a 14% gain.

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SPX Chart

One could make a bullish case that with the market hitting 1370 on Thursday, it held the March low. And intra-day, the S&P 500 had fallen 12% from its high in June, which puts us in correction territory. Corrections in a bull market are normal and healthy - as long as we're in a bull market.

So the question is do we buy here?

If you are a trader, I think the answer is "yes." I expect the market to rally, maybe hard, today and into next week. We are very oversold.

The technicals say we are. By almost every indicator I look at, we are at extreme levels. Also, as I understand it, today's options expiration is leaning heavily to the puts, which will force market participants to buy stock to cover.

Finally, I am hearing the equity swaps market is offering highly attractive terms for taking the long side, suggesting there are too many betting the market will continue to fall.

But I think the nature of the market has changed, and rallies are to be sold.

  • First, unlike a few months ago, credit conditions are worse.
  • Second, the mortgage market is still a mess. With next year being the peak in ARM resets, there will be more convulsions in the mortgage market.
  • Third, the Fed is not on the market's side, as witnessed by St. Louis Fed President's statement on Thursday that the Fed won't intervene unless there is a "calamity" in the market. Also, Helicopter Ben Dr. Bernanke Sir is disinclined to bail out markets, unlike his predecessor Easy Al. (I'll have more on this in a subsequent post.)
  • Fourth, central banks have been tightening around the world. Bear markets are usually preceded by increases in interest rates. The myopia of the average American investor may lead him/her to conclude that since the Fed has stopped raising rates, tightening has been over for some time. That would be wrong. Central banks have been tightening around the world. This matters more than ever because America is more reliant than ever on foreign sources of capital. Even if central banks begin cutting, markets usually don't bottom right at the very top of the interest rate cycle, which is where we would be globally.
  • Fifth, the problems in housing are not going away. There is simply too much inventory.
  • Sixth, though we shouldn't invest by the calendar, after five years of gains, this bull market is looking long in the tooth.
  • Seventh, as odd as it might sound, I don't think there is enough fear in the market. There seems to be too many willing to buy this dip. I don't know how many money managers I saw on Bubblevision nonplussed by all this. (Apart from the money manager from Dallas on On the Money tonight who was beat red, almost exploding over his assertion that the Fed absolutely had to cut rates.) I also noticed that Thursday morning when I went to the Audio Visual page on Bloomberg (AV ), where they offer you 10 clips they highlight, every clip with a money manager had the manager telling you to buy stocks.
  • Perhaps I'm wrong, though, and this is the bottom of the next leg up. I'll change my mind on a dime if I think I am.

    But I could be wrong about a rally over the next few days. Here is Japan as I type.

    Nikkei Chart

    And did you see Canada? It was down nearly 600 points intra-day.

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    TSX Chart

    I have heard comparisons of the current sell-off to the sell-off in 1998 sell-off, which looked like this.

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    SPX 1998 chart

    The market fell 22% top to bottom in 1998 before rebounding. Since June, the market fell 12% from the high to today's low.

    I expect a bounce, but I plan to sell into it.