An unexpected rally—but where do we go from here?
The past few days provided a surprising rally—at least it surprised me. Stocks were losing ground the final week of July and it appeared they were poised to go even lower. But that changed with the new month and a strong up day on Monday. Since bottoming at the end of June, major indices have staged a month-long advance in spite of economic news that has been predominantly negative.
The chart below shows the S&P 500 for 2010. I added the red line so you can see that in spite of plenty of volatility along the way, the index is currently just about where it was at the start of the year. The middle portion of the chart is a relative strength index (RSI). This indicator is currently hovering above the 50 mark, which means there is positive momentum. The bottom portion of the chart is a stochastic oscillator. It has reached a level that reflects an overbought situation. In other words, the current condition is like a tightly stretched rubber band. Some of the tension needs to be released. So a pullback from this point is likely. It could be a small correction like we saw at the end of July. Or it could be more significant like the one in the latter part of June.
Although there are plenty of negative economic reports, there is also a lot of cash sitting on the sidelines that is available to go into the market. Worried traders and investors are nervous about jumping into stocks. But when stocks start advancing like they have over the past month, some of those investors get nervous about missing out so they will start buying which propels the markets forward.
Back in my days as a communications student in college, I was required to take some broadcasting classes. One of the lessons about television broadcasting focused on something called “least objectionable programming.” The basic concept was that if you were producing a show for broadcasting, you did not necessarily have to create a great program. Instead, you just needed to something that was marginally better that whatever else was showing during that time slot and viewers would choose your offering.
A similar phenomenon occurs in the financial markets. When traders and investors are looking around and trying to decide where they should allocate their available cash, in a down market many are just trying to avoid the worst options. Return rates on secure products like CDs and bond yields are historically low—perhaps 3% or 4% a year. And those investments require a long commitment. The S&P 500 just gained 9% in July. The possibility of a higher return will appeal to many investors, even though the risk of loss is also much greater.
Some consolidation is likely for the next few sessions. But as the summer draws to a close, it would not be surprising to see stocks move even higher—even with continued weak economic numbers. Logic would indicate that it should be hard for the markets to advance with high unemployment and a struggling housing market. But investors might decide that stocks still offer a better opportunity than the other choices available to them.