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AFTER THE WORST AUGUST SINCE 2001 was over, the promise of a new month supplied the tinder for a trio of sparks provided by hints of economic strength in China, Australia and in U.S. manufacturing that lit up the stock market with gains of more than 2% Wednesday.
Unfortunately for the bulls, the new month is September — the worst month of the year in terms of average performance. History suggests prices will be appreciably lower in a month's time.
But that does not mean the market cannot recoup a bit more of its August losses first. Indeed, sentiment had gotten a bit bleak with at least one reading — the American Association of Individual Investors (AAII) survey — showing the highest ratio of bears compared to bulls since the March 2009 market bottom. When bearishness gets widespread, the market tends to confound the consensus by going up.
Not all sentiment surveys were this extreme, however; as of Aug. 25 even the AAII percentage of bears was just shy of 50%. That is a far cry from the 70% it recorded in March 2009 at the market's bottom. In other words, sentiment was bearish enough for a bounce but not the start of a new bull market.
What is most interesting about Wednesday's action was that the Standard & Poor's 500 had gained back half of its August loss before midday (see Chart 1), which should put the hyperbole in perspective. August was not so bad, and considering the size of the 7% July gain, a correction was to be expected.
Chart 1
But for me, the dominant theme for the market remains random noise within the declining trend in place since April.
Moreover, as stocks have fallen for the past four months, bonds have risen — a lot. Since stocks peaked on April 26, the iShares Trust Barclays 7-10 Year Treasury Bond Fund (ticker: IEF) gained 9.6%. In contrast (see Chart 2), the S&P 500 is down 11.7% — including Wednesday's big rally.
Chart 2
There appears to have been a mass exodus of investor capital from stocks and into bonds. Demand in all areas of the bond market was so strong that it continued to signal economic fear (see Getting Technical, "Don't Ignore the Bond Market's Worries," Aug. 9, 2010).
Bubble talk seems to be the rage in the financial press. With the 7-10 Year Treasury ETF approaching prices not seen since the heart of the financial crisis in 2008, there is reason to think about an overextended market.
Indeed, the bits of good economic news Wednesday did quell some fears of a double-dip recession, and Treasuries sold off significantly. But we've seen that action before as many analysts invoking the "B" word — bubble — are equally quick to say bonds are toast at the first sign of selling.
But so far, the 7-10 Year Treasury ETF has been resilient. It shrugged off last Friday's huge decline to set a new closing high for the current rally before facing another big decline Wednesday. More importantly, the rising trendline from April remains intact with a bit more room for prices to correct lower.
Kevin Daly, the emerging-market debt portfolio manager for Aberdeen Asset Managers in London, says that "it may appear to be bubble-like at the moment, but with U.S. growth indicators softening and the Fed likely to be on hold through 2011, U.S. Treasury yields are unlikely to climb anytime soon."
As the Japanese bond market has shown, interest rates can get very low and stay that way for years, with the benchmark 10-year yield hovering around 1%. For the U.S. market, if low yields and high prices persist, it may keep investor capital locked up in bonds and unavailable to support stocks.
In other words, bonds have not given up the ghost just yet, which can keep the pressure on stocks. For the short term, stocks can bounce back a bit as the bears take a breather, as I wrote here last week (see Getting Technical, "Head-and-Shoulders Portend Double-Dip," Aug. 25, 2010).) But unless the bulls can mount a sustained advance with significant inflows of money, I see no reason to think about a new bull market.
Getting Technical Mailbag:Send your questions on technical analysis to us at online.editors@barrons.com. We'll cover as many as we can, but please remember that we cannot give investment advice.
Michael Kahn, mutual fund co-manager, author of three books on technical analysis, former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, also blogs at www.quicktakespro.com/blog.
Comments? E-mail us at online.editors@barrons.com
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