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Is an Oversold Rally in the Works?


Stocks may be set to rebound following recent weakness.

MINYANVILLE ORIGINAL What we have witnessed over the course of the past seven weeks following the equity markets peak is a delayed reaction in price to the overall underlying health of the broader market.

From a technical standpoint, our markets peaked in February, yet price drifted marginally higher. As the S&P 500 (^GSPC) rang the bell on our target of 1365 +/- 15 basis point handles, we paused. It was not a shorting opportunity, based upon the persistent bearishness that grew as price moved higher. But after weeks of basing between our levels, the market set itself up for a sprint higher into 1420, suggesting but not reaching irrational exuberance. From that intersection, we saw price decelerate in a downward spiral by 115 handles, or about 9%.

So we must ask ourselves the one question that is more important than Facebook's (FB) $104 billion IPO: Are we still in a healthy sustained upward move, or are we in a state of bearishness that is being masked by love for Apple (AAPL) or Facebook?

Is our market in a state to handle such a large issuance? Recall that we topped out on the Carlyle IPO last month. Only Father Time knows this answer, and as I stressed yesterday in the Buzz & Banter, I might be my own best contra-indicator. There are many warning signs that suggest something bigger than we are able to anticipate may in fact be on its way. (See: Dreams of a Market Downdraft Drifting in the Distance.)

World markets across the board are in free fall. Make no mistake, I, too, see the oversold conditions and provided a list of reasons recently to prepare for the forthcoming "bounce." I even went as far as to suggest that our markets could make all-time new highs based upon said sentiment and previous presidential election cycles. (See: Why Stocks Can Make New All-Time Highs.) My assertion is that historically markets "cascade" lower during moments of an oversold and technically damaged environment, which is our current state. The NYSE advancing vs. declining issues is at an inflection point that warrants caution.

Since the start of the week, I have been warning of a widening junk bonds (JNK) to Treasury ratio, coupled with a rapid expansion of new 52-week lows. This has superseded every downward market "event." Yesterday, we witnessed a closing low on the 10-Year Treasury at 1.70%.

This is demonstrating the flight to quality and fear that is prevalent in investors' minds. I have been opining from the short side of the US Treasury market since the first quarter began. (See: I Shorted the United States Treasury Market.) What we are seeing right now is an outlier to why I suggested caution in the near-term short treasury trade; it is one final blow-off top to treasuries prior to initiating the great re-allocation trade out of bonds and into stocks.

The bond market always knows more than the stock market. It is the ultimate teller of truth. The US dollar is also near a major inflection point. It is lagging the VIX and TLT breakout and breakdown points I highlighted late last week as cause for caution. Recent dip-buying and the refusal for capitulation in anticipation of Wall Street's darling IPO, Facebook, has created a no-fear buying opportunity predicated upon a bullish bias and complacency that has become commonplace for weeks.

The stage is set for an oversold rally. Yesterday, we saw over one million put contracts trade on the SPY (which is 2.5 times average daily volume) after having traded over 900,000 put contracts the previous day, which was the second highest in 2012. It's imminent... or is it? The possibility of a move higher from here is large, but our objectives in managing capital are protection, preservation, and a responsible return over time. It is with this notion that we must decipher both sides of the equation to arrive at the most appropriate answer.

Our markets are attempting to tell us something and my intention is to present and see both sides. We are stretched and at an extreme moment. We will break and it can go two ways.
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No positions in stocks mentioned.

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