The Bounce

Well it finally happened.  The widely anticipated bounce in the S&P500 has arrived, and it was a big one. The index jumped 5.6% last week. The bad news was that volume fell.  This means that the spike in prices didn’t happen because new buyers rushed in (that would be good news and a reason to expect a strong follow through).  Instead, prices rose primarily because short sellers covered there bets, and by doing so, they shoved prices much higher.  So this was a professional, computer-driven reaction that the general public had nothing to do with.

In the economy, the news was mixed.  Personal incomes were lower than expected; spending only met expectations (which were for zero growth, month-over-month).  Worse still, when inflation is factored in, real incomes decreased.  Also, all of the modest increase in nominal incomes came from government transfer payments (think unemployment insurance, for example) which is not sustainable. Consumer confidence fell, when it was expected to rise.  Initial jobless claims also disappointed—again coming in deep into the 400 thousand range.  Consumer sentiment was worse than expected, as was construction spending.  ISM manufacturing was stronger than the regional Fed surveys were hinting it would be, but the dreaded drop in the ISM was probably only postponed until next month.

Technically, the S&P has established a new uptrend on the daily charts.  Last week’s move higher however, was unusual.  As already noted, the swiftness and severity of the rise smacks of short covering, not new and enthusiastic buying.  Also, this surge—though only a week old—has already hit many overbought levels.  It would be very unusual for the pace of this rise to continue.  If anything, a pullback would not be out of the question.

That said, over the next week or so, the power of last week’s rise does suggest that there may be some follow through.  New money, money that was on the sidelines sitting out the prior two month decline, might start to jump in and nibble on stocks.

Sadly, this new buying does nothing to take away the longer range risks, risks that have not only not gone away, but have arguably grown larger.

The Fed’s QE2 money printing program officially ended last week.  This single factor explains as much as 90% of the stock market’s advance from last year.  So with the money pump shut down, the stock markets will be very vulnerable to declines.  The timing between this shut down and stock price declines is tricky.  Last year, after QE1 ended, stocks advanced for another three weeks before turning down in earnest.  This suggests that another couple of weeks of advances should not surprise anyone, and this would mesh well with the technical, momentum follow-through effects pointed out above.

Also, the prime reason for the last week’s surge—the relief that Greece will not default—is far from a true and permanent fix.  The can has merely been kicked down the road, perhaps for only a couple of months, until the early fall, when Greece will need still more money to avoid a default.  And this Greek BandAid does nothing to fix the growing, and possibly explosive, problems in Portugal, Ireland, Spain and now Italy.  Any one of these nations could explode with a financial crisis at any time, judging by their terrifyingly high government bond yields.

So while the S&P500’s 200 day moving average held, as postulated here last week, all of the forces that dragged the S&P down to this support level, in the first place, have not gone away.  At best, they’re taking a short break.  So the need to batten down the hatches has not been eliminated; it’s simply been postponed.

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