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Relief Rally, or Just Bull?


Six indicators to help you tell the difference.

I said the following in my Words from the Wise post on Sunday:

"At this juncture, short-term movements are almost impossible to predict, although the sell-off over the past few days -- a capitulation in some respects -- could nourish the long-awaited tradeable rally. Also, Lowry's 90% down-days, like we experienced on Monday and Thursday, are often followed by 2- to 7-day bounces."

Global equities surged yesterday as investors adopted a more positive view of the prospects for the banking sector and shrugged aside gloom about the economy. The reversal in fortune is illustrated by the strong gains of the MSCI World Index and the MSCI Emerging Markets Index of 5.3% and 3.6% respectively.

In the US, the S&P 500 Index (+6.4%) experienced its biggest 1-day gain since November 21, as financial shorts were covered and "sidelined cash" was deployed, resulting in a long-absent 90% up-day.

The surge in prices again raises the question: Was yesterday the bottom? Before getting too far ahead of ourselves, Bespoke highlights the fact that yesterday's gain was the eighth 1-day gain of 5% or more since the S&P 500 peaked in October 2007. None of the previous occasions resulted in a sustained rally, as shown by the graph below.

Given the fact that the rally occurred against a level of extremely bearish sentiment, and that the oversold market has probably started exhausting itself (at least in the short term with the S&P 500 having seen only 3 up-days over the 16 trading days prior to yesterday), a rally may be in bloom. Should we see higher prices over the next week or so, the more important question will be whether we're dealing with anything more than an oversold bounce.

There are a few indicators I'll be monitoring closely, as summarized below.

1. Prices increased yesterday on the largest volume since November 21. The up/down volume spread -- determined by subtracting the volume of declining issues on the NYSE from advancing issues -- needs to show sustained expansion as prices rise.

2. Similarly, the advance/decline spread, measuring the breadth of a stock-market advance, needs to see advancing issues outpacing declining issues on a steady basis; i.e., a rising trend as far as the cumulative figure is concerned.

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