After the long weekend, we saw the DOW gap up over 500 points on Tuesday’s open and the S&P 500 finished the day up over 2.45%. The Nasdaq finished strong too and all of this action is happening a week after big selling brought the market indicators into an oversold reading. You can see how the daily stochastics indicator on the S&P 500 chart are both below 20, signalling oversold.
In a bull market I’d be thinking that Tuesday’s action would lead to a big rally, but with the market below its 150 and 200-day moving averages we are not in a bull market. In bear markets you often get one day wonder rallies when the market is oversold and sometimes rallies that last a week or two and then come to an end like that last one in May did.
One big clue, though, to whether this rally will lead to anything is the action in the bond market, which the stock market has been closely tied to this year. The action in the JNK bond ETF has tended to lead the action in the S&P 500. When JNK has held up and then started to rally the stock market followed in May, but when JNK has made peaks and had big reversal down days such action has signaled that rallies won’t last.
That is exactly what happened on Tuesday.
JNK gapped up on Tuesday just as the stock market did, but JNK then dumped back into the red instead of going up like the stock market.
So, the action in the bond market did not confirm Tuesday’s stock market rally.
Therefore, I would not expect much out of the rally action.
With the market deeply oversold, however, I wouldn’t be expecting a big plunge here either.
Most likely the stock market won’t do much this week except go back and forth.
Oversold readings often get worked off by sideways action.
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-Mike
