The largest two-day bounce in the Nasdaq since February has market players feeling better after weeks of poor action, but it is too early to be comfortable that a sustained uptrend is developing. The big bounces always occur in the worst market environments, but this sort of action can easily turn into a bull trap.
Despite the extremely strong move, there are many market participants that are concerned about the upcoming CPI report on Friday. With Jerome Powell already indicating a more hawkish bias, the market is grappling with the acceleration of the Fed tapering off its bond buying and the potential for interest rate hikes in 2022.
This issue is a big part of the reason the market has struggled recently, so it is discounted to some degree, but it is a very convenient justification for another pullback in the indexes.
Inflation fears are obvious, but it has not stopped very aggressive buying in the last couple of days. Market players have seen these energetic V-shaped bounces quite often in recent years, and they tend to fear being left out more than they fear being caught in another selloff.
Technically the market needs a rest at this point. Ideally it should trade flat to slightly down and allow stocks to digest the recent gains. Volatility has been very elevated lately and what is needed more than anything is some calm and consolidation.
There still is positive seasonality into the end of the year, but tax selling is likely to be more intense this year due to some of the changes in state laws regarding capital gains and the likelihood of higher federal taxes next year. In addition, the huge disparity of action between big-caps and the rest of the market is going to drive some tax-loss selling in smaller stocks to offset gains in bigger stocks.
At this juncture, we need to stay very focused on price action. A pullback would be quite healthy, but if it goes too far, there will be a problem. There would have to be a substantial drop to test recent lows, and even if we give back half of the recent gains, it is going to have an impact on sentiment.
I'll be managing positions tightly and will continue to watch for better technical patterns to develop.