The Sharper The Rally, The Better The Short

by: James A. Kostohryz

Global markets are rallying this morning based on rather flimsy premises of firming German and French support for Greece.

So far the support offered by German Chancellor Angela Merkel and French President Nicolas Sarkozy has been purely rhetorical. Meanwhile, it seems like the bureaucrats in both countries are preparing for Greek default.

Real support for Greece would actually make a great deal of sense for one basic reason: It will be a great deal cheaper to support Greece than it will be to place a firewall to protect Spain and Italy from Greek contagion.

But alas, it seems that German notions of rectitude take precedence to strategic concerns or even national self-interest. Thus, this relief rally based on European declarations of support for Greece will be short-lived.

In the US, market participants are gearing up the next Fed meeting. Traders and investors seem to be sniffing out the prospect of more “money printing” and the Pavlovian response is akin to a pack of hungry dogs smelling red meat.

However, for reasons detailed here, it seems quite unlikely that market participants will be getting much more than a doggie biscuit or two.

The real issue in the medium term is whether September economic data reported in October might show a rebound in economic activity. This scenario is plausible.

At this time, what intrigues me even more than the rather flimsy fundamental basis for the current relief rally are its technical characteristics: It has been characterized by almost vertical assents on relatively light volume interspersed with sharp-intraday sell-offs. This is a telltale sign that most of the buying is not from strong-handed institutional buyers. Such moves suggest HFT magnified short-covering out of deeply oversold territory and well as momentum trading.

Such rallies can be sharp, but they don’t tend to last. Without improvement in the delta of macro-fundamentals that have been driving the current correction and the re-emergence of fundamental buyers the path of least resistance for US equities (SPY, DIA, QQQ) will remain downward in the medium term.

Having said that, it would be a mistake to get overly bearish. First, policy makers in the US and Europe have the policy tools to aver disaster in the short and medium terms. Second, perhaps the best thing that the market has going for it right now is that it is already discounting plenty of bad news for the next decade, and many stocks such as Apple (AAPL), Microsoft (MSFT), Intel (INTC), AT&T (T), Verizon (VZ) and even some financials such as Goldman Sachs (GS) exhibit tremendous fundamental value relative to their profitability and growth prospects. This will tend to provide downside support for the market (^SPX, ^DJIA, ^IXIC).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.