Did Monday’s Rally Change Much?

August 4, 2014 1:46 PM

Stocks Rally On Bailout: While bailouts in the U.S. have thankfully been rare in recent years, they are still a part of investing worldwide. From Reuters:

Bond prices rallied and European bank stocks rose on Monday after Portugal devised a plan to prevent the collapse of one of its biggest lenders. Lisbon on Sunday announced a nearly 5 billion-euro ($6.6 billion) rescue of the country’s largest listed bank, Banco Espirito Santo, preventing it from collapsing and potentially destabilizing the regional banking sector.

Stocks, Risk, and Probabilities

Risk management is about assessing probabilities and making adjustments as needed. In the world of investing, common sense tells us when the odds are favorable we should be willing to put more capital into growth-oriented assets. Conversely, when the odds are unfavorable, it is prudent to eliminate or reduce risk exposure.

Trends Speak To Probabilities

The chart of the NYSE Composite Index on the left below shows a bullish period in 2014 during which the odds of investment success were favorable. The version of the chart on the right shows a period in 2008 during which the odds of investment success were unfavorable. Said another way, the chart on the left shows a bullish weekly trend and the version on the right shows a bearish weekly trend in stocks.

Did Monday’s Rally Change Much?

From a weekly trend perspective, the answer is no. The chart on the left shows the weekly NYSE Composite Index as of Friday’s close. The version on the right is as of the close Monday. The trend was clearly bearish on Friday; it remained bearish Monday.

Earnings – Much More To Come

One thing that could offset increasing concerns about a Fed rate hike is higher corporate earnings. Last week was big in terms of economic data; this week will be dominated by earnings. From Bloomberg:

Some 72 companies including Walt Disney Co. and Time Warner Inc. report earnings this week. Of the companies that have posted results so far this season, 76 percent beat earnings estimates and 65 percent exceeded sales projections, according to data compiled by Bloomberg.

How Much Damage Last Week?

This week’s stock market video looks at risk and reward following last week’s selloff in stocks.

Investment Implications – The Weight Of The Evidence

Taken in isolation, a 14 point rally in the S&P 500 on Monday afternoon does not reverse the damage done by last week’s 53 point drop. We need to see observable changes that point to a more favorable environment, rather than a one-day bounce. The NYSE Composite as of Monday’s close is shown at the top of the image below. Does Monday look more like the bullish trend on the left or the bearish trend on the right? The beauty of charts and math is it is difficult to let bias distort the answer, which is “Monday still looks like a bearish weekly trend”. Could stocks recover and resume the previous uptrend? Sure, but there is no need to anticipate or guess. We need to see more for our longer-term focus. If the chart below improves, we are happy to adjust.

In case you are wondering, if we asked the same questions about the S&P 500 after Monday’s close, we would get the same answers of “not much has changed yet”.

Bulls Want To Recapture 1965 on S&P 500

If we continue to monitor the evidence with a flexible and open mind, the market will guide us. For now, the evidence calls for a prudent mix of stocks (SPY), cash, and bonds (TLT). We will be more impressed if the bulls can recapture 1965 on the S&P 500 (see chart below).

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