The major U.S. stock indexes closed higher on Thursday, recovering from a steep sell-off shortly after the cash market opening and the release of weaker-than-expected U.S. services sector data. Usually traders get excited about closing price reversal bottoms like the one we saw yesterday, but this one has a different feel especially after the bad news about the manufacturing sector earlier in the week.
In the cash markets on Thursday, the benchmark S&P 500 Index settled at 2910.63, up 23.02 or +0.82%. The blue chip Dow Jones Industrial Average finished at 26201.04, up 122.42 or +0.48% and the technology-based NASDAQ Composite closed at 7872.27, up 87.02 or 1.14%.
Rally Nothing But Short-Covering
We could build a case that investors searching for value came in to stop the price slide on Thursday, after all, the three major indexes were trading slightly below a 61.8% correction of their August 6 to September 12-13 trading range.
We could also build a case for traders anticipating a rate cut by the Fed at the end of October after the CME Group’s FedWatch tool showed expectations for an October rate cut jumped to 93.5% from 77% on Wednesday. This is because the money managers running Wall Street have been trained to buy stocks when the Fed cuts.
However, I tend to believe that short-sellers just decided to book profits after the steep losses this week ahead of Friday’s U.S. Non-Farm Payrolls report. The uncertainty that usually accompanies this report was enough to encourage short-sellers to trim positions.
Technical traders also contributed to the recovery in the indexes. Many amateur counter-trend buyers attempted to buy the indexes when they tested their two month Fibonacci levels as if they had enough power to stop the selling with passive bidding. And many amateur counter-trend buyers were probably stopped out when sellers took out the Fibonacci level and drove the indexes to their lows of the day.
After getting beat up on that attempt the buyers were shy about reentering the market. The market didn’t start to rally because of bottom-pickers, they were stopped out. The market stopped going down when the selling stopped. Big difference.
Once the markets recaptured the Fibonacci levels on the chart, the shorts began to cover aggressively, leading to today’s higher close.
Stocks versus Bonds
The big takeaway for me on Thursday is that stock market investors still believe the Fed has the power to turnaround the economy. Since I tend to watch the bond market for my validation of the strength of the economy and not the level of the Dow Jones Industrial Average, or S&P 500 Index, I believe that investors have lost faith in the Fed’s ability to revitalize the economy and get keep the expansion on track.
On Tuesday, I noted the movement in the asset classes: Stocks sold off, Treasury bonds reversed to upside, gold reversed to the upside, the Japanese Yen reversed to the upside and the U.S. Dollar reversed to the downside.
On Thursday, stocks rallied, Treasury bonds rallied, gold rallied, the Japanese Yen rallied and the U.S. Dollar was down for the session against a basket of currencies.
If the stock market rally on Thursday meant anything more than just a short-covering rally then we would have seen aggressive selling in the safe-haven assets, but we didn’t.
I will say that professional stock investors are creative so it is possible that they went long stocks, with protection in bonds, gold and Yen. This may lead to some follow-through buying early Friday, but I don’t think a stock market rally will last unless investors dump the safe-havens. If this occurs then I’ll have to say that sentiment has shifted back to the upside at least in the short-run.
This article was originally posted on FX Empire
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