Wow, the market did not go down this week. While the S&P 500, and its tracking exchange traded fund, SPY, has fallen nearly 10% in the last month, stocks have managed to rally nearly 3% this week, starting with the market stabilizing on Monday.
Many leading stocks such as Apple (NASDAQ:AAPL) and Citigroup (NYSE:C) have fallen more than 15% from their earlier year highs. Cyclical sectors such as energy, the industrials, and the financials, have also sold-off significantly more than most of the broader indexes as well.
I wrote several days ago in an article that the market would likely continue to rally since a number of the most oversold sectors, such as energy and the financials, appeared to be reaching a short-term bottom. While all traders have good calls and bad ones, that call was correct. Still, now that the market has rallied nearly 3% in two days, I think it's interesting to analyze the strength of the recent move up.
The first reason the rally will likely fail is that there has not been any significant and positive news that is driving this rally. While the market rallied into the European Central Bank's announcement, the ECB's decision not to cut rates can only be viewed as a disappointment. Also, while media links hinted at new possible stimulus if the growth outlook continues to deteriorate, the Fed seems unwilling to intervene ahead of the presidential election. Leaders in China have also suggested that any near-term stimulus would likely be different than the country's previous construction and infrastructure build-out, and the Chinese central bank cut lending and deposit rates only a quarter basis point.
In my experience, usually when you have a large sell-off, the market needs to regain confidence before it begins to move meaningfully higher. While many traders and investors in the financial community remain optimistic about the prospect of a third round of quantitative easing, the ECB seems unwilling to take aggressive actions ahead of the Greek elections, and the Fed also seems hesitant to act aggressively while Congress and the White House are not pursuing any significant new fiscal initiatives to boost growth.
The second reason the rally will likely end this week is that the market is rallying with no leadership. While big cap tech and the financials led the nearly six month rally from the summer of last year, Apple actually closed weaker than where the stock was trading last week. While the financials rallied nearly 10% this week, companies such as Citigroup and JP Morgan (NYSE:JPM) sold-off over 30% in the last month. The continually negative news coming from Europe, with recent downgrades of German and Austria banks this week, will also likely weigh on this sector. The dollar also held its 20 day moving average, suggesting commodities may remain weak as the economic growth outlook continues to weaken.
The third reason the rally may be short-lived is the very poor volume in the market during the recent rally. While volume levels have been below average for much of the year, the Wednesday rally was on an anemic 760 million shares traded, and volume has been very poor most of the week. While rallies sometime start on low volume, volume was significantly above average during the sell-off last week, and volume was low again on Thursday as well. With many traders likely heavily short the market, it is likely the rally was more a short squeeze after the market temporarily stabilized on Monday than a real reversal with strong buyers.
To conclude, while I maintain that stocks are undervalued, the Fed and the ECB seem unwilling to take significant action in the near-term. Still, with no likely major news events in the next couple weeks, continually disappointing economic data, and concerning recent financial news coming out of Europe, the path of least resistance remains down. While valuations remain reasonable, and yields on many leading S&P 500 companies, such as GE and Chevron (NYSE:CVX), are approaching 4%, long-term investors will likely have to regain confidence in the growth outlook, as well as the willingness of Central Banks and government leaders to take new and aggressive actions, before reallocating significant new capital to the market.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.