Lack of hopeful economic data has made it difficult for the deeply oversold stock market to find a trigger for a meaningful and sustainable rebound.
The Federal Reserve’s annual symposium in Jackson Hole, Wyoming, always a closely watched event, was of extra interest to the financial markets this year. But Fed Chief Ben Bernanke’s vague speech on Friday revealed nothing that was not already heard in recent weeks.
While no another quantitative easing (QE) was mentioned during Bernanke’s speech, he did say that the Fed has a range of tools available to provide additional monetary stimulus, as appropriate, to promote stronger economic recovery. The intraday price swings in equity, bond and commodity markets during Bernanke’s speech on Friday ended up with all markets up on the day. In that respect, the symposium has proven a great success, at least for the markets, on that one day.
The below chart is the update of the chart I previously featured in April 2011. At that time, I had thought that the June 30 ending of QE2 was a bearish factor and the market was likely to sell off well ahead of June 30. My guess that the odds of the market adage, “Sell in May and go away,” were likely to pay off this year has turned out to be on the money.
The benefits of the two QE programs have been dramatically more evident in financial and commodity markets than in the economy. The money the Fed pumped out flooded the markets, with only a trickle left to help where it was needed most—the economy.
Though the Fed may credit the two QEs for the huge two-year gain in stock prices, it remains to be seen if the same monetary tool will be used in the upcoming months. After all, what benefit can the Fed buying more U.S. Treasuries bring to the economy when treasury yields of all maturities and classes are currently at their all-time lows?
Over the past few weeks, institutional investors panicked by the deteriorating economy and deepening crisis in Europe stampeded into the U.S. Treasury market leaving it grossly over-bought and ripe for a setback (higher yields).
Should the direct correlation between stocks and the yields on U.S. Treasuries continue to hold, the S&P 500 could rebound towards the neckline of the recently completed head-and-shoulders top, currently in the 1,260-1,270 range on the S&P 500 (in simple language, stocks could rally here). That would represent a 61.8% retracement of the May 5 to August 8 decline of 19.6% on the S&P 500.
However, if the stock market does not rediscover its ability to “climb the walls of worry,” a downside breakout would likely turn into a full-grown grizzly bear with downside potential as low as 890 to 900 on the S&P 500. On the whole, even though the market is severely oversold, I do not believe that this is as big a buying opportunity as March 2009 was.