There is no denying that the U.S. stock market has enjoyed a dramatic turnaround over the last 25 trading days. The S&P 500 has rallied 12.05% since the February 11 low, the DJIA has added nearly 2,000 points (1942 to be exact), and the NASDAQ has gained 12.4%. Not bad, not bad at all.
On February 11th, traders thought the oil bust was going to drag the U.S. economy into recession. On February 11th, the worry was that the banks were in trouble. And on February 11th, the bears were firmly in control of the action.
Then it happened – the expected oversold bounce began. As is usually the case in this type of situation, stocks surged up from an oversold condition. Things had simply gotten too negative. Three days later, the most recent leg down had been erased and things were looking/feeling a bit better.
Even the most ardent bear expected this bounce. Everybody knows that stocks rarely, if ever, move in a straight line and when the environment becomes as negative as it had been in mid-February, a dead-cat bounce is just part of the game. But few gave the move much chance of continuing as the damage done to the markets had become severe.
But continue it did. Right through the near-term resistance. Right through the key moving averages. And right through the Fibonacci retracement levels – despite the fact that all of the above were expected to provide to stop this bounce in its tracks.
S&P 500 – Daily
So, 25 trading days later, the stock market appears to be out of the danger zone and the bulls are talking about new all-time highs.
The Question of the Day Is…
But before we get too excited, it is important to take a step back and look at the causes of the rebound and then to try and answer the obvious question: Is the move sustainable?
If investors have learned anything since the credit crisis, it is that when things start to get bad, the world’s central bankers have tended to saddle up their white horses and ride to the rescue. Over and over again. And sure enough, this time was no different.
Just about the time everyone was sure that the bears were back and that a replay of 2008 was at hand, the People’s Bank of China, the Bank of Japan, and Mario Draghi got busy. And by now, every trader worth their salt knows how to play the central bank intervention game.
Along with surprise moves in China and talk of more QE in Europe came improved economic data in the U.S. And by the time Super Mario got around to actually firing his QE bazooka, stocks were in the process of discounting better days ahead.
To be sure, things have improved in the markets. The economic outlook is a better. The banks are better. And my longer-term, big picture indicators are better.
However, it is important to recognize that oil too has enjoyed a strong rally over the period of time in question. And given that stocks and crude have been joined at the hip for quite some time now, I have to question whether the current rally is anything more than a continuation of the oil correlation trade.
Lest we forget, the USO has popped more than 32% during the stock market rally. And while the daily correlation between oil and stocks seems to be fading a bit, the bottom line is that when oil goes up, stocks go up.
US Oil Fund (NYSE: USO) – Daily
It is important to recognize that oil probably doesn’t have to continue rally for stocks to improve further. The key was for crude’s rude move to end. And with oil now up off the mat, the argument can be made that the chance of contagion now must be reduced as well.
However, as the weekly chart of oil shows, the situation in the oil patch isn’t suddenly “all better now.”
US Oil Fund (NYSE: USO) – Weekly
Then if we take a look at the weekly chart of the S&P 500, it is fairly clear that we should perhaps keep the champagne on ice for a while yet – at least until the bulls can break the downtrend and/or make a new high.
S&P 500 – Weekly
In summary, things have definitely improved for stock market investors on many fronts and we may indeed be out of the danger zone. However, until stocks can decouple from oil and show that they can rally without the help of green arrows in the oil pit, I’m going to try and curb my enthusiasm.
In short, my plan, as always, is to stay in tune with the overall risk/reward environment, which, at this stage, means a high neutral to moderately positive stance.