Five Day Rally, For Real?

Just looking at the charts for the S&P 500 today, I am a little surprised at the move we are seeing so far today. We are coming off of a down week last week, but nothing too surprising given the circumstance that the market was trading off. Since a new low was made last Wednesday at 1364 (and a subsequent reversal rally that day), the market has rallied nearly 50 points (3.5%) from those lows. That is a pretty substantial move in a market that reading the media, you would have thought the world’s economies were crumbling. Quite to the contrary, world markets look to have stabilized, although it could very well be a head fake in another move lower. The Shanghai Index, which fell 9% on February 27th, has regained 5.2%. Hong Kong’s Hang Seng index has regained 3.1% in the past five trading days and even the German Dax index has increased 3.7% in the last week. These are all great rallies, but what is the core reasoning behind the move?

Let’s focus on the U.S. since that is really what we know most about. First, last week was an expiration week; therefore, historically it has a bullish bias. Could that be the main reason for the market’s gains? The follow through the first two trading days this week has me thinking that something else is behind the move.

The data that has been presented in the past week has been mixed at best, so this might not be the greatest catalyst. On Tuesday, retail sales came in at +0.1% vs. +0.3% expected, while sales ex-auto were -0.1% vs. a +0.3% estimate. These are weak and the downtrend in consumer spending has continued (see chart below, click to enlarge).

Wednesday is what I believe could have been a key reversal day, yet it was the same day that Asian markets were down 2-3% and European markets were down 1-2% respectively. It looked like the morning weakness was based on overseas trading and the subprime mortgage mess, but midday, the markets reversed. Why? It is possible that all the sellers were washed out and the bulls took control, but there was no real catalyst to the move. With inflation numbers out the next two mornings, it could have been ugly. When the PPI and CPI report came out slightly hotter than expected the markets continued to try and push higher, but the end of week volatility and expiration closed the markets near 1400, or about the same point the key reversal day closed its interesting day. No change for the last two days of trading for the week.

That brings us to yesterday and today. Yesterday, the morning gap of 10 points was never filled in throughout the day as the market traded higher just as overseas markets had done the same morning. The slow grind upward lacked both volatility and the presence of sellers. Why wouldn’t the sellers have come in at any point and started pressuring the market? It could be because they are waiting to hear what the Fed has to say on Wednesday during the FOMC announcement. They are expected to keep rates at 5.25% (a 98% chance, according to the markets), yet their statement may have some indication of the latest subprime meltdown. If the statement is upbeat, it will be good news for the bulls, but if it has any tone of worry, we may see the sellers come back to play and drive the S&P back to its lows near 1364 or even lower.

Take a look at the chart below. You can see the market is sitting right at the thick red line, which is one I have drawn as a resistance area. Technically, it is very strong as the red line indicates both a prior resistance area and a 38.2% retracement using the February highs and the first low made in March (see below, click to enlarge). This number is critical as it also happens to come into play during the FOMC meeting. It could very well be a re-test before breaking lower. We will see what happens tomorrow afternoon, but keep in mind the intermediate trend is still downward, even with a 3% gain in the past five trading sessions.

Source: Briefing.com, eSignal