Rev's Forum: Can the Bulls Pull Off Another V-Shaped Bounce?

 | May 19, 2017 | 7:14 AM EDT
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"Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected."

--George Soros 

The market produced a weak bounce on Thursday following the worst day for the indices in many months. Early indications are for some continuation of the recovery, but the technical picture is problematic. Bounces that lack vigor are more prone to failure, and this one didn't possess much energy.

The good news is that in the age of computer algorithms and suppressed human emotions the typical technical patterns don't always apply. As anyone who has followed the market closely over the last few years will know, there is a much greater potential for V-shaped bounces than there has been in the past.

Rather than sell into recovery, the relieved bulls just keep on buying and act as if nothing has changed. The theory behind selling into bounces is that folks are happy to escape a situation that had turned unpleasant. When the market bounces back they make their exit and then they can enjoy a good night's sleep once again.

That simple psychology has changed quite a bit in recent years. The computers are programmed to take advantage of the obvious human emotion. When there is tendency to sell, the computers will take the other side of the trade and try to push things higher. This causes the bears to be squeezed and the underinvested bulls to panic. Rather than a bounce rolling over, we end up with a V-shaped move once again.

The bears are comfortable that this time the recovery won't be so easy. The political chaos that triggered the Wednesday selloff is far from resolved, and there are other negatives brewing such as the situation in Brazil, negative seasonality and a more hawkish Fed. To what degree these issues change the narrative we will see soon enough.

Keep in mind that oversold bounces like the one that is occurring can last longer than you think. The psychology of bounces is that they will make you feel that the problems have been resolved and it is safe to jump back in for the recovery. They occur because emotions cool off and the fear that was in place is so quickly forgotten.

When bounces fail, downtrends develop. When prior lows are breached, traders make their exits and downside momentum starts to build. Whether the current pullback is just another one-day situation or something more dire we will have to see. The key initially is that the recent lows hold. That means the S&P 500 needs to stay above the 2352-2356 area. If that falls, especially on a closing basis, the character of the action will undergo a very negative shift.

We have a little more bounce action this morning. The mood is more upbeat as Brazil has recovered some and oil is stronger in front of an OPEC meeting. The Trump drama has cooled off as well and folks are looking forward to a summer weekend.

Whether this is another V-shaped recovery we will need to wait and see, but for now we need to give the bounce a bit more room to run.

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