Why this market will NOT give up its gains.
We’ve seen this story play out again and again. Problems in Europe, and the market sells off. Solutions in Europe, the market rallies. Oh wait, more trouble in Europe, the market sells off again. The S&P has been on this roller-coaster ride for the past two years, trading off European headlines.
The most recent EU deal has allowed the S&P to tack on 40 handles since yesterday afternoon. Many traders, having seen this story play out before, are playing this market from the short side this afternoon, trying to fade this rally.
Short-term though, I think these traders are wrong. There was terrible news from Barclays yesterday, regarding the possible manipulation of LIBOR. Three other banks including HSBC, RBS, and Citigroup may also be involved. The JP Morgan whale trade losses may be approaching $9 billion. All of this news made it appear that the bears were in complete control. Traders added to their short positions, and long traders threw in the towel, as we approached critical support in the S&P at 1300.
But then, yesterday afternoon, we had a vicious rally. Bears who had added to their positions in the morning were put under serious pressure in the afternoon and were scrambling for offers. A short-squeeze ensued. This caused the market to rally back and recoup the majority of it’s losses by the end of the day. But still some bears were thinking that the rally was overdone, and they held strong. Some even added to their short positions at the close. Then BOOM! Overnight, more good news from Europe, and those traders caught short are now in serious trouble.
Short squeezes build the foundation for all market rallies. Shorts are the first participants to hit the buy button as they try to lock in profits, or limit losses. This gets the ball rolling, so to speak. As more and more shorts scramble to cover, high frequency traders, sensing the sudden demand, drive the market higher as well. Eventually, as the market rallies, real traders start to come in and continue driving prices higher.
This is exactly what has happened in the past two days, and I believe that this market could continue to rally for these reasons.
Now under normal circumstances, I might think that this market could give back it’s gains. But today is not a normal day. It is the end of the quarter, and you can be sure that the big boys will not allow this market to give up these gains, as they try to impress their clients with their end of the quarter statements. So I would expect this market to close strong today. This will put major pressure on any traders who are still holding on to their short positions, as well as any traders who initiated short positions by fading today’s opening.
There is one more major catalyst, earnings season. Earnings season is just around the corner, and that could drive this market even higher.
When you consider the short-squeeze which we are currently enduring, the end of the quarter push higher, and earnings season just around the corner, I think this market has the foundation built to continue this rally, at least in the short-term. The bears were in complete control yesterday morning, but today, the bulls are taking control, and in the short-term they may just be able to put those bears into hibernation.