Free Newsletter: Stalking Stocks with the Shark - Textbook Oversold Rally - 7/16/08

Free Newsletter: Stalking Stocks with the Shark - Textbook Oversold Rally - 7/16/08

Greetings Shark Investors:

The oversold bounce that just about everyone had been waiting for finally kicked in on Wednesday as investors overlooked discouraging inflation data and a downbeat Fed and focused instead on another drop in crude prices and surprising earnings results. It was a bumpy ride ahead of the opening bell as index futures changed from red to green and back to red. Early indications were for a slightly negative start to the day following the previous day’s dismal close, but sentiment improved markedly after WFC and SCHW both reported earnings that were well ahead of analyst estimates. However, hotter-than-expected consumer inflation data dampened the mood once again.

That choppy action carried over after the opening bell as the major indices fell into the red, turned green and then fell back towards the flat-line within the first hour of trading. However, the action improved markedly after the weekly oil inventory data showed a build of 2.95 million barrels versus an expected decline of 2.2 million barrels. As such, just about the entire market moved to fresh highs with tech, industrials, consumer discretionary and healthcare sporting decent gains. The real action, however, was in the financials, which by mid-morning were ahead by about 7%.

While the action was still a bit choppy for the rest of the morning, the major indices began to march steadily higher just as the New York lunch hour got under way. From that point on, almost every area of the market, save energy and utilities, continued to move steadily higher. Even some very gloomy comments regarding second-half growth and inflation in the minutes from the Fed’s most recent meeting failed to slow the relentless push higher. By the end of the day, each of the major indices closed with gains, on average, of 2.71%, with the financials finishing an eye-popping 12.41% higher.

Without a doubt, it was a strong day, and was a perfect example of how oversold bounces can develop in a bear market. Just a couple of days ago, concerns over the failure of IndyMac and emergency government actions caused tremendous strain on an already fragile market. However, all of those worries were cast aside as shorts rushed to cover their positions and longs scrambled to add exposure. Once that kind of action begins to feed on itself, it can lead to what are often some of the most vigorous moves to the upside. That said, the key is to see if we will at last see some follow-thorough to the upside in the days ahead. Given how many times bounces over the past two months have turned out to be one-day affairs, it’s hard to put much trust into this one.

However, as we have been pointing out, earnings season may very well turn out to provide the catalysts this market needs for a more tradable counter-trend move to develop. We’ll get another test on Thursday when more financial companies, including JPM, MER, ZION and COF tell us how the second quarter went.