Stock Market Rally: First Stage Of A Primary Bull Trend?

“Sell in May and go away” may not be relevant this year. For a month commonly associated with disinterested stock market activity, we have seen a 36% jump in the benchmark S&P 500 from March’s 12-year low.

Economic reports turn out better than expected, swine flu has been downgraded to a harmless entity, and US banks have passed the stress test. No wonder, investors are seeing green shoots everywhere, even among a pile of stinking, toxic shit.

Speaking of the stress test, there are much debates on the methodologies, “adverse” assumptions or suitability of a 25-to-l leverage ratio for tier-1 capital, but it is undeniable that uncertainty has been eliminated substantially.

Since the test procedures are out in public, investors can extrapolate their own worst case scenarios based on current recommendations and findings. Unless the Treasury Department has prepetrated a fraud out of this stress test, it is the most authoritative guide to date.

Judging by the resilience in the stock market rally, the Obama administration has skilfully orchestrated leaks and pre-release discussions with banks to test market reaction. Come to think of it, there is no way the US government will let the banks fail, not when they have unwittingly become a major, if not the biggest, shareholder vested in the banks’ profitability. The auto industry will have given an arm to be in this position but apparently, life is full of inequality.

In the short term, technical indicators, measures of confidence, and volatility all suggest that the stock market rally could persist. We are now either in the last stage of the bear reign or the first wave of a primary bull market.

A representative measure of a stock market rally is the S&P 500 lying less than 50 points away from the 200-day moving average. If the S&P 500 closes above this closely watched metric (something not seen since December 2007), the trend reversal from bearish to bullish cannot be ignored.

The VIX index also slid to its lowest level since the collapse in September 2008 of the US investment bank Lehman Brothers. With market volatility abating, investors have grown accustomed to the effects of a tight credit market and are betting that the worst of the recession is over. They believe that a renewed stock market rally is taking root.

There is also lots of money, in the region of trillions of dollars in household cash, sitting on the sidelines. What began as a massive and impulsive short covering off a historically oversold bottom will now attract all these idle cash. Having missed out on the lucrative actions, value investors are keen to play catch-up in the stock market. As such, we can expect equities to move up another 15-20 percent from their current positions.

Strong technical indicators have formed not only in global stock markets but also for depressed commodities like oil, base metals and agricultural products. Nevertheless, after such a heady run in the stock market, a major correction is imminent. That will be healthy for consolidation purposes. Over the next 2-3 months, we should expect a range bound trading where the bulls and bears slug it out.

Optimists will use this period to buy the dips to accumulate positions providing strong support. On the other hand, any uptrend will face strong technical resistance as bears reposition for an anticipated decline by selling rallies. Longs which have their money trapped for a long time will also sell into these rallies.

I believe the overall effect will be the stock market hovering between the 50 and 200 EMA’s for several months. If the primary bull trend is to develop, the crossover has to happen convincingly. Meanwhile, economic reports must continue to show gradual improvement.

Since inflation is bound to return with a vengeance, we must prepare to move a portion of our money back into assets which provide strong capital gains and income. I don’t encourage any speculation in penny stocks as there are many companies with dubious balance sheets, still flirting with bankruptcy. They will continue with their scams under this illusion of wealth and prosperity.

To be sure, real economic progress must depend on increased productivity through technological innovation, not manipulation of stock market by hedge funds or financial engineering. Thus, all the money created out of thin air by the Federal reserve must be channelled properly to product tangible benefits, else we will face another super bubble in another few years time.

And not to forget, the most pivotal moments in the swine flu saga are yet to come. Will it roar back in the regular influenza season and affect the rest of the world. The fear is that it could evolve into a more lethal strain and bring all economic activity to a standstill.

Like the swine flu, the financial crisis may have another, and hopefully, the last outburst before exhausting itself. This will be violent, so stay focused on the technical and fundamental indicators if you decide to accumulate positions in the stock market aggressively.

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6 Comments

Filed under Economy, Stocks

6 Responses to Stock Market Rally: First Stage Of A Primary Bull Trend?

  1. Pingback: TheTradingReport » Blog Archive » NewsFlasher Editor’s Picks for May 10 2009

  2. The optimism you express in the article seems a little premature if for no other reason that so far the overall economic news is only less bad than previously. Unemployment continues to increase but maybe a little slower, US banks continue to fail, industrial output is far from boyant, etc.,etc.
    Technical indicators may be pointing towards a stock market recovery and investor risk appetite is returning but the outlook for a sustained recovery is likely to remain doubtful until positive results from the majority of leading companies are announced for at least two quarters.
    I hope that you are correct that markets will stay range bound for the next few months but I suspect a swoon back down to the lows may occur when, rather than if, further bad news is announced.
    Factoring in the inflation scenario leaves a question of timing. Should it take off before sustained recovery is perceived then the only bets are gold and silver. Otherwise, as is hopefully more likely, the economy rebounds first then top class companies, picked up when yields are high will be an attractive alternative to gold and silver.

  3. @ John -

    I am far from optimistic actually. In fact, the stock market boom has caused me lots of worry. Toxic waste in the banks are not eliminated fully and the only thing preventing a widespread collapse is the unwavering support of the US government which will intervene.

    Bringing down the bank is akin to bringing down the US government which is an unlikely scenario.

    You mention that “a swoon back down to the lows may occur when, rather than if, further bad news is announced” which is my sentiment too.

    This is a period when the pendulum can swing either way. Staying in full cash or investing with abandon are too extreme. The best way is to dollar cost average and accumulate positions gradually.

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  6. Come to think of it, there is no way the US government will let the banks fail
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