The biggest bounces occur in the worst markets. We have a good illustration of that phenomena in the early going as the DJIA is indicated to open up over 300 points. There is a collective sigh of relief after overseas markets turned up and interest rates have stabilized.
Technical conditions are good for a bounce after yesterday's failed attempt. An afternoon selloff left the indices oversold and the mood quite sour. Traders were too anxious for a bounce yesterday morning and the pre-market bounce fizzled out quickly after the open. The bargain hunters were unable to generate much upside and buyers gave up again late in the day and produced another ugly finish.
While the bounce this morning is a relief it is not reason for a high level of trust. Many market players have been trapped in positions during the downtrend over the past couple weeks and they will be looking for ways to escape some of the stocks that have caused misery. A sizable bounce this morning will help ease some of the pain of the worst week for many since February.
In recent years many market players have grown used to V-shaped bounces after sharp pullbacks. Technical resistance hasn't seemed to matter much but market conditions have shifted this year and the recoveries are not as quick and easy as they once where. The conventional wisdom is that after a sharp pullback the market will not go straight back up because there will be some longs that will want to escape the stocks that have caused them stress and there will be bears that want to reload shorts.
There is a natural inclination for market players to sell a position when they are close to breakeven after they have suffered through a period of large losses. They feel they have to avoid disaster just to get their money back. They forget why they bought the stock in the first place and are happy to return to the sidelines.
Overhead resistance is what causes bounces to fizzle out but in a market that is dominated by computer algorithms, the price action can be quite different than what we'd expect when it's human emotion driving the action. The algorithms tend to accentuate trend moves which is why we have seen so many V-shaped bounces in recent years.
The good news about a bounce like we are seeing this morning is that it helps create some obvious technical levels. Yesterday the S&P 500 hit a low around 2710 which will now become the key level that everyone will be watching. Bulls will look for a retest that holds if the current bounce fails and the bears will be looking for that support level to fall, and another leg down to follow.
Much of what happens today is going to be a function of the response to reports from several large banks. Citigroup (C) , JPMorgan Chase (JPM) , Wells Fargo (WFC) and PNC (PNC) all report earnings this morning. The group has been under pressure the last couple days as concerns about loan demand and the yield curve have come to the forefront.
One of the big positives about earnings season is that it should help to shift the focus away from macro concerns that have caused the recent volatility and back to finding good values and opportunities in individual stocks. Corrective action like we have seen always eventually leads to a good environment for stock pickers and that is especially so during earnings season.
We have a bright green open on the way but the reaction to bank earnings reports will be key.