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Markets Aren’t Out of the Woods Yet

0 | By Shah Gilani

After a heart-pounding seven-day slide, stocks staged a spectacular rally yesterday.

The first question investors need to ask themselves is, “was it a dead cat bounce?”

Then they need to ask themselves, “will central bank rate cuts be enough to stop another market downturn?”

And last, but not least, investors need to ask, “How will they know it’s safe to be 100% invested again?”

Here are the short answers.

What’s a “Dead Cat Bounce”?

Yes, the spectacular run-up in stocks yesterday was a dead cat bounce.

A “dead cat bounce” is old Wall Street parlance. The first time I heard it in 1982, I was on the Floor of the Chicago Board of Options Exchange (CBOE) and stocks had been selling-off. The Fed announced they were doing “reverse repos” (a short-term transaction that injects money into the financial system), and within an hour, markets rallied, erasing the past few days of losses in what seemed like no time flat.

I turned to the head trader of Salomon Brothers options trading desk and said, “Now that’s a rally!” He smiled at the new kid on the block and said, “It’s a dead cat bounce, that’s all.”

I said, “what’s a dead cat bounce?” He replied without a hint of sarcasm, “You ever seen a dead cat bounce when it falls?”

It means the bounce you’re seeing out of a dead market can’t be trusted because dead markets don’t bounce like that.

After markets lost 12% to 14% in a matter of days, depending on which market gauge you watch, and stocks had become extraordinarily “oversold” based on every stochastic measure imaginable, some kind of bounce was inevitable.

Yesterday’s bounce was based on how big the prior seven-days of selling had been.

There were thousands of stocks that looked cheap. As buyers came in, especially computer-driven algorithms and high-frequency trading “bots,” and “took offers,” the positive feedback loop of taking offers which lifts prices, which makes buying attractive, brought in more buyers taking more offers just to get into beaten-down stocks while they were cheap, led to the rally that took stocks to their highs of the day at the close of trading.

The bounce wasn’t unexpected, only the magnitude of it.

But, that’s a function of market mechanics, how many exchange venues there are now, how computers drive trading, how high-frequency trading shops read investors trading orders while they’re on the way to exchanges and front-run them, it’s just mechanics. And it works both ways, on huge up days and huge down days. It’s how we’re able to see multiple 1,000 point moves in the Dow, especially on the downside, and it looks almost “orderly.”

Yeah, market mechanics are scary.

And, just because mechanically stocks soared in a day, doesn’t mean they can’t fall back just as fast, exactly like they did the previous seven days.

Central banks to the rescue?

I say good luck with that.

Lowering rates, even a “concerted” lowering of rates by several central banks working together, in the face of already low rates, isn’t going to be economically stimulative.

Besides, the flight-to-quality trading that’s driven hundreds of billions of dollars into U.S. Treasuries, for example, has already dramatically lowered rates!

Central banks lowering rates now is like opening the barn door after the horses have already bolted.

Lower rates aren’t going to get consumers out if they’re scared to go out or if they can’t go out. They aren’t going to induce capital spending by companies if companies don’t know where demand will come from or when it will come back.

Besides, when the coast is clear and the coronavirus is behind us, central banks will have to start pulling back the stimulus they intend to flood economies with. Markets know that’s the other side of lowering rates in an eventually passing crisis.

So, no, lowering rates isn’t going to put a hard-and-fast support under weak markets.

That’s because markets are looking at economies and sales and revenues and earnings and profits…and now losses. Those economic realities are reflected in stock prices.

Looking and Listening for the “All Clear!”

Investors need to be listening to what’s happening with the spread of the novel coronavirus and looking for sustainable market support levels.

Even if markets level out at or bounce off support levels, investors need to listen to what progress is being made on the coronavirus. Markets can find support and rally, but if there’s no definitive good news on the coronavirus, all rallies and resting support levels are suspect.

Because markets quickly discount rumors and move ahead of news, including good news, an absolute all-clear bell doesn’t have to be rung. Investors just need to know the tide has turned, that’s the bell investors should be listening for.

As far as support levels, here are the Dow’s support levels and what to look for as stocks reach, test, and trade around them.

The near support for the Dow Jones Industrials Average is 26,500.

If the Average can consolidate around that level, generally trading above there for a while, that level could be a launching pad for stocks to make a run higher to 27,000.

If stocks get above 27,000 and hold that level, consider that a bullish sign.

If the Dow can’t hold 26,500 its next support level is 26,000. Support there will a positive but isn’t strong support.

Support at 25,500 is important; if the Dow can’t hold there, consolidate, and start to move higher, look out below.

The next support for the Dow is its 52-week lows around 24,680.

Below that support, all bets are off.

Now you know why we’re not out of the woods yet.

Sincerely,


Shah

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