Morning Thoughts Friday October 28

A little consensus and shifting a good amount of the debt burden to the banks was all it took from Europe and markets went bananas over it.  I guess after all the back and forth by European officials over recent months it was a relative improvement.  But all is not resolved quite yet.  In fact, any of these proposals still have to be implemented and who is to say there won’t be hurdles along the way.  Another major issue is whether the Greek debt write-down constitutes as a credit event (default) that would trigger credit default swap payments.   

When it was all set and done yesterday however the rally in stocks led most major U.S. equity indices to close up between almost three and six percent on the day.  The eighteen day rally tally looks like this: 

  • S&P 500 up 17% in 18 trading days
  • Nasdaq 100 up 15.5% in 18 trading days
  • Russell 200 up 26% in 18 trading days
  • SOX semiconductors index up 21.5% in 18 trading days

The S&P 500 as well as many of its sectors has now broken every last technical point of resistance; lateral resistance near 1230, the 61.8% Fibonacci retracement level near 1260, and even the 200 day simple moving average at 1275.  Such are bear market rallies however, they are violent, sharp and pretty much no one makes money from them.  Given the viciousness of bear market rallies and how closely market participants hone in on certain levels of the major equity indices however it is also not surprising to see them overshoot those levels only to eventually fall back below them.  Such at the moment seems to be the case on the major U.S. equity indices.  Given last night’s major announcement out of Europe we must now allow some time for the dust to settle.  Even recent history can give us some potentially relevant guidance to this when stocks were bid much higher on the announcement of the TARP program only to falter after some time later.  

While both the S&P 500 and the Nasdaq have rallied past most resistance points, the Russell 2000 small cap index is displaying more classical technical behavior.  On the chart below note that the index is still below, albeit very near its 200 day simple moving average (red line) and exactly at the important 61.8% Fibonacci retracement level from the May to October sell-off.  As small cap stocks tend to give off leading signals we want to keep a close look out for any potential major reversal signals on this chart.

The banks of course led the entire rally higher and by looking at the KBW Bank Index (BKX) note that it broke above the $40 area and has technically broken higher.  Also note however that resistance is just a few points away, so getting excited about a ton of additional upside at these heights may be dangerous.

Also please remember that rallies that turn vertical, such as the one we are currently witnessing, often have sharp corrections.  We remain in a bear market rally and given the magnitude of the rally in such a short time-frame in addition to major resistance areas on equities, commodities, as well as currencies it is not my action of choice to chase this rally.  Rather I will look for exhaustion points that would allow select short-side opportunities with defined risk.

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