Monday's Short Covering Rally

Includes: SPY
by: Stock Traders Daily


Friday's data was big news.

Investors implemented risk controls last week.

And now those risk controls are being reversed.

Monday's market action after the oddly-timed employment report on Friday is not a surprise. Institutional investors had plenty of time to digest the news, and although the futures market indicated a sharply lower open, futures on the S&P 500 were down much more about an hour before the market opened, the rationale of the street was somewhat normal.

When Wall Street reacts to events they tend to react to things that are happening right now. I know that they say that the stock market is the best discounting mechanism that we have and we all know that investors can look ahead to discern what will happen going forward when making decisions to buy or sell today, but in situations like we're facing now where anxieties ran high leading up to a news announcement the reactions are not always as forward-looking as some might believe.

Anxieties leading up to important news events often prompt investors to take action ahead of those events. Some might use option strategies, some might use short-selling strategies, and some may use other strategies to mitigate risk, but in all cases mitigating risk is the focal point leading up to big news. Uncertainty like what we were witness to last week before the employment data absolutely prompted investors to take positions to mitigate risk just in case the data was good.

Therein lies part of the reason for today's action. The risk everyone surmised last week was that the data would be good, better than expectations, and that would prompt the FOMC to increase interest rates sooner than later. As we know, the opposite was true and the data came in much weaker than expectations suggesting that the FOMC could put off the timing of its interest rate increase.

Immediately, that meant that the risk controls that were implemented late last week no longer needed to be there because the immediate risk no longer existed. They say that the street forgets fast, they also say that investors look at their feet more than they do down the road, and today would be a great example of that.

Investors are giddy, but it is more like relief than anything else. They are relieved that the weak data did not cause the market to fall hard, but the only reason that the market is this strong is that the risk controls that were implemented last week are no longer needed. In many ways this can be considered a short-covering rally as a result.

By suggesting this I'm not suggesting that the rally reverse itself immediately. It can, we will certainly have more volatility, but it is important for us all to identify the increase and the strength for what it is.

This is, by every measure, a short-covering rally.

In addition, although the FOMC may not be compelled to raise interest rates immediately, they are still compelled to raise interest rates sometime soon. It is not as if the risks have gone away, they have simply been put off. With earnings season on the horizon it is also reasonable for us to suggest that additional risks are likely to surface soon, but the market may be in a void right now because no negative news events appear front and center like they did late last week. That is relieving, that allows some investors to take risk controls off the table, but institutional investors know quite certainly that the risks have not gone away and we should recognize that too.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: By Thomas H. Kee for Stock Traders Daily and neither receives compensation from the publicly traded companies listed herein for writing this article.