The Dow has puffed up nearly 600 points in a week on the thinnest of fumes: a short-term bounce in the euro and some amnesia about the European debt crisis.
While the advance has been a relief to U.S. investors who watched stocks plunge 12% in the previous six weeks, many market pros think the path of least resistance remains to the downside. That’s partly because the issues that caused the selloff haven’t disappeared and partly because the selloff was pretty small relative to the rally that preceded it.
Between the 12-year lows hit in March 2009 at the height of the financial crisis, and the highs of late April, the S&P 500 gained 80%. Since then, the major gauges have fallen into a correction - a slump of more than 10% off the highs, but not a bear market - a slump of at least 20% off the highs. Many experts think the market needs to lose more before it can move ahead.
Working in favor of the rally: Technical factors, historical precedent and signs of an improving economy.
The S&P 500 and other major gauges have cleared key technical trading hurdles that could pave the way for more short-term stock gains, according to Sam Stovall, chief investment strategist at Standard & Poor’s. Most recently, the S&P 500 cleared the 200-day moving average — a key level watched by market pros.
From a historical standpoint, if the market remains in a tight range for awhile, chances are the corrections will end. The selloff has so far topped out at 13.7% on the S&P, just managing to avoid the 15%-plus that tends to bring in a bear market.
And finally, economists still think the U.S. can avoid a double-dip recession, although growth is likely to be tepid.
Working against the rally? A laundry list of road blocks.
Five little PIIGS: Worries about the European debt situation spreading to the U.S. plagued stocks during the late April to early June selloff, with investors doubting that the $1 trillion loan package would be enough to ease the crisis.
But those concerns waned in the last week as global stocks rallied. Investors seemed to focus more on positives like a jump in industrial output in Europe rather than negatives like Moody’s downgrade of Greece’s debt to junk. Greece has already accessed billions of dollars in loans and had its debt cut to junk by Standard & Poor’s last month.
Wednesday brought an about face as Spain’s debt yield spiked to a record high on bets the country will need a bailout to avoid defaulting on its borrowings. Portugal, Ireland and Italy also saw their debt yields rise.
Elsewhere in the world, concerns that China’s growth is starting to slow and is facing higher inflationary-pressures continue to drag, although the country recently reported a strong jump in its exports, a good sign.
Euro bounce likely to fade: The euro had recovered about 3% as the stock market rallied, bouncing from a four-year low of $1.188 last week. But the European currency retreated again Wednesday, leaving its year-to-date losses at about 15%.
The currency has essentially been a proxy for investor worries about Europe’s problems and is expected to keep moving lower, perhaps hitting parity with the dollar by next year. The stronger dollar has cut into dollar-traded commodity prices and pressured so-called multinational companies that benefit from a cheaper dollar.
Summer doldrums: As is typical this time of year, trading volume has slowed down, with less action coinciding with lower attendance levels as market pros hit the beach. Lower volume levels tend to exacerbate volatility and indicate less conviction behind trading moves.
Although individual investors put some money into equity mutual funds over the last week, according to funds tracker Trim Tabs, total trading volume has dropped.
In the first three days of this week, as stocks gained, New York Stock Exchange trading volume slowed to an average of 1.2 billion shares per day. Funny thing is, volume seems to spike back up on days when the market is plunging. During the six-week selloff, volume averaged 1.8 billion to 1.9 billion a day, hitting a 20-month high of 2.58 billion on May 6 — the day of the "flash crash."
Kitchen sink: Everything from the continued fallout of the BP (BP) oil spill, to tensions between North and South Korea to the latest setbacks for the U.S. housing and labor markets continue to underpin sentiment.
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