David Moenning

About the Author David Moenning

David Moenning is a the Chief Investment Officer at Heritage Capital, which focuses on active risk management of the U.S. stock market. Dave is also the proprietor of StateoftheMarkets.com, which provides free and subscription-based portfolio services. Dave began his investment career in 1980 and has been an independent money manager since 1987. Thus, Dave has been live on the firing line and investing for a living for more than 25 years.

The Short-Term Oversold Conditions Have Become Extrem

By Donald Moenning

The past three sessions the U.S. stock market has followed China’s lead, plunging -8.96% in that short time. With the Shanghai Composite down another -7.6% overnight (now -15.5% this week), at quick glance it seems like we’re in for another rocky session.

However, futures indicate a big rebound at the open stateside. Dow futures are up +543 points, while S&P 500 futures are up +64.75 points. European markets are rallying sharply, with Germany up +4.40% and France up +4.54%.

Oversold conditions and signs of capitulation continue to garner a lot of attention in China, and market contagion is a growing concern.

So, what gives? With China posting another abysmal session, and the situation seemingly getting worse by the day, why are markets elsewhere poised for a big rebound this morning?

First off, the big news. China cut interest rates for the fifth time in nine months on Tuesday in an effort to shore up slowing economic growth. The central bank said the benchmark 1-yr rate would be cut by 0.25% to 4.6%, among other slight adjustments. While this was a move that was mostly expected, it has given the situation in China a “band-aid” of sorts this morning, though many financial experts are not convinced that the move will save China’s plummeting prices.

The other news this morning is from U.S. firms regarding the state of the economy here in the U.S. Goldman Sachs said it expects the U.S. economy will avoid contagion and continue to expand, and that the S&P 500 will rise 11% to 2,100 by the end of 2015. It also said that this type of rebound would echo the trading pattern exhibited in 1998, when U.S. equities rallied and largely ignored the Asian financial crisis.

JPMorgan was a bit less bold, saying it remained cautious in the short-term, but ultimately views a deep correction as “unlikely.” The firm stated that a U.S. recession is also unlikely as growth remains on a sustainably path with housing and consumption cycles not exhausted.

Finally, BofA Merill Lynch said European markets are deeply oversold and due for a rebound.

The bottom line is that U.S. firms aren’t convinced that China is going to drag the U.S. market with it down into a recession, and that the short-term oversold conditions have become extreme. This, coupled with the interest rate cut in China has U.S stocks poised for a big bounce this morning after three miserable days. The big questions today will be two fold – 1) How much of the opening bounce will be captured by the closing bell? 2) Is this simply a “dead cat bounce,” or the start of a legitimate rebound in the short-term?

After such extreme selling the past few sessions, a big bounce would not be surprising. However, it is what happens over the next few sessions that will be telling. Will we continue to follow China’s lead, or is enough enough?


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