The DJIA soared 323 points on Thursday and the S&P 500 posted its biggest one-day percentage gain since the first day of trading in 2013 (a move that coincidentally was also sponsored by Congress finding a way to avoid sending the economy into a depression).
Although yesterday's move left many investors scratching their heads, the reason for the joyride to the upside can be summed up in one simple phrase: a path forward is developing.
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After finishing lower almost daily for the last three weeks, stocks were clearly oversold. As such, a bounce was certainly to be expected at some point. However, Thursday's blast wasn't the prototypical oversold bounce. No, this one had some oomph behind it as shorts scrambled for cover, dip-buyers did their thing, and all those opportunistic fast-money types that had been looking for a sign that it was safe to get back into the pool dove in as well.
There are two question from here, of course. First, why did stocks suddenly and without warning reverse course? And second, will the rally hold up given that there is still no deal in sight and the deadline remains a long way off?
The short answer to the first question is that traders have been implementing the government-crisis trading play book developed in 2011. Here's the way it works.
The Play Book
First, stocks are sold off in earnest on the fear that the government might default on its debt and create a recession/depression along the way.
This fear causes sellers to become more active and buyers to simply stand aside. The thinking on the buy side of the equation is simple; why buy now when stocks are likely to go lower until the deadline occurs? The combination of emboldened sellers and buyers sitting on their hands creates a vacuum. Whoosh, down they go.
Stocks then continue to head lower due to the fact that a deal to save the day won't occur until right before (or right after) the well-publicized deadline. Each passing day creates more tension, more uncertainty, and more doubt. And while logic dictates that Congress wouldn't do anything to actually harm the country or the economy, as the debate becomes more acrimonious, doubt on this topic continues to creep in.
But then, just when it looks like the deadline clock will expire and the economic calamity being predicted by the bears will actually occur, Congress pulls a rabbit out of their hat and somehow, some way, makes a deal. Stocks soar in response as traders breathe a sigh of relief. Short-covering ensues and before you know it, the entire worry-induced decline is erased.
But This Time Around...
However, this time around the game was played a little differently. In the beginning, traders didn't want to buy into the game. The bottom line is nobody wanted to get fooled again. After buying into the doom and gloom being espoused at the end of 2012, traders didn't appear interested in biting on the idea that Congress might actually cause the sky to fall this time. But as this drama has unfolded and neither side has appeared willing to budge, the fear of what might happen clearly took hold.
Just as the play book calls for, a vacuum was created and stocks then started to tank. With the President doing nothing, the Tea Party making unreasonable demands, and the Democrats sitting on their #Winning position, it became clear that nothing was going to get done before the October 17th deadline. Therefore, the fast-money types thought they had a no-brainer trade to the short side.
However, what short sellers didn't count on was the idea that the Republicans might not want to take the blame for this thing going south. So, with plenty of time left on the clock, the negotiations began again. And as the saying goes, as long as the two sides are talking, nothing bad is going to happen. Suddenly the doom and gloom scenario has been removed. Boom, the bulls look to be back in business.
Will It Stick?
The next question investors face is whether or not the Thursday move will stick. The bears contend that there are many twists and turns left in this drama/debate and that there is still no guarantee that a deal will get done.
In fact, the headlines came fast and furious out of Washington Thursday evening. First, the White House announced that Obama had rejected the GOP debt limit plan (because they didn't do exactly what he wanted). Then House Majority Leader Eric Cantor said that talks are expected to continue into the night. So, to say that this remains a fluid situation is an understatement.
The key however, is that the two sides are indeed talking. They are clearly not talking nicely and there is no Kumbaya moment at hand. But given that the GOP has backed away from the early demands related to ObamaCare, it does appear that there is a possible path forward to an eventual deal. So, even if a deal doesn't get done until the very last minute, as long as there is hope for a deal, stocks could easily remain buoyant.
Current Market Drivers
We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).
1. The Games Being Played in Washington (I.E. the Gov't Shutdown and Debt Ceiling) 2. The Outlook for the U.S. Economy 3. The State of Fed Policy 4. The State of the Earnings Season
The State of the Trend
We believe it is important to analyze the market using multiple time-frames. We define short-term as 3 days to 3 weeks, intermediate-term as 3 weeks to 3 months, and long-term as 3 months or more. Below are our current ratings of the three primary trends:
Short-Term Trend: Neutral (Chart below is S&P 500 daily over past 1 month)
Intermediate-Term Trend: Moderately Positive (Chart below is S&P 500 daily over past 6 months)
Long-Term Trend: Positive (Chart below is S&P 500 daily over past 12 months)
Key Technical Areas:
Traders as well as computerized algorithms are generally keenly aware of the important technical levels on the charts from a short-term basis. Below are the levels we deem important to watch today:
- Near-Term Support Zone(s) for S&P 500: 1680, 1660
- Near-Term Resistance Zone(s): 1700
The State of the Tape
Momentum indicators are designed to tell us about the technical health of a trend - I.E. if there is any "oomph" behind the move. Below are a handful of our favorite indicators relating to the market's "mo"...
- Trend and Breadth Confirmation Indicator: Neutral
- Price Thrust Indicator:Neutral
- Volume Thrust Indicator:Moderately Negative
- Breadth Thrust Indicator:Moderately Negative
- Bull/Bear Volume Relationship: Moderately Positive
- Technical Health of 100 Industry Groups: Moderately Positive
The Early Warning Indicators
Markets travel in cycles. Thus we must constantly be on the lookout for changes in the direction of the trend. Looking at market sentiment and the overbought/sold conditions can provide "early warning signs" that a trend change may be near.
- Overbought/Oversold Condition: The S&P 500 is neutral from a short-term perspective and is slightly oversold from an intermediate-term point of view.
- Market Sentiment: Our primary sentiment model is neutral .
The State of the Market Environment
One of the keys to long-term success in the stock market is stay in tune with the market's "big picture" environment in terms of risk versus reward because different market environments require different investing strategies. To help us identify the current environment, we look to our longer-term State of the Markets Model. This model is designed to tell us when risk factors are high, low, or uncertain. In short, this longer-term oriented, weekly model tells us whether the odds favor the bulls, bears, or neither team.
Weekly State of the Market Model Reading: positive
If you are looking for a disciplined, rules-based system to help guide your market exposure, check out The Daily Decision System.
Turning To This Morning...
Optimism ran high on Wall Street Thursday in the hope that a deal would get done to avoid a debt default in the U.S.. However, today the focus remains on the actual negotiations in D.C. and the reality is that the two sides remain far apart. This morning investors were treated to earnings from JPMorgan Chase and will also get some economic data to review. At this stage, futures point to a flat open on Wall Street.
Here are the Pre-Market indicators we review each morning before the opening bell...
Major Foreign Markets: - Japan: +1.48% - Hong Kong: +1.16% - Shanghai: +1.69% - London: +0.74% - Germany: +0.39% - France: +0.02% - Italy: -0.12% - Spain: -0.23%
Crude Oil Futures: +$1.32 to $101.69
Gold: -$9.10 to $1287.80
Dollar: lower against the yen, euro and pound.
10-Year Bond Yield: Currently trading at 2.688%
Stock Futures Ahead of Open in U.S. (relative to fair value): - S&P 500: -0.11 - Dow Jones Industrial Average: +1 - NASDAQ Composite: -6.39
Thought For The Day...
He is richest who is content with the least --Socrates
Looking for Guidance in the Markets?
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At StateoftheMarkets.com, our goal is to provide everything you need to be a more successful investor: The must-read headlines, market commentary, market research, stock analysis, proprietary risk management models, and most importantly actionable portfolios with live trade alerts.
Finally, we are here to help - so don't hesitate to call with questions, comments, or ideas at 1-877-440-9464.
Wishing you green screens and all the best for a great day,
David D. Moenning Founder and Chief Investment Strategist StateoftheMarkets.com
For up to the minute updates on the market's driving forces, Follow Me on Twitter: @StateDave (Twitter is the new Ticker Tape)
Positions in stocks mentioned: none
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