Suckers rally

June 8, 20122 Comments

Suckers Rally example using the S&P 500 chart

A suckers rally is a term used to describe a temporary and often misleading increase in the price of a security or the overall market. It refers to a situation where prices rise, giving the appearance of a strong and sustainable upward trend, but the underlying fundamentals do not support such a move.

A week ago (last Friday June 1st), the S&P 500 suffered its worst one-day drop in more than 100 days.  Then on Wednesday it enjoyed its largest one-day gain in more than 100 days.  Meanwhile, the S&P held above its 200-day moving average, an important indicator followed by many traders (red line on chart). My blog last week suggested that the spike below the 200 day MA was temporary and should not be of concern just yet, and the markets might rally. Score one for that call (hey, I’m wrong at times too, and do admit it when I am!).

I feel that the recent rally will not last. I think it’s a dead-cat bounce, a fools rally, or a suckers rally, call it what you will. Technically, short termed resistance at just under 1340 is being tested. There are factors that make the markets continue to look dicey. For example: There are no concrete plans in Europe to solve their very significant problems. Bernanke gave no clear guidance as to what his stimulus plans might be on Thursdays Fed meeting. Greek elections (June 17th) and the European Summit (end of June) are still looming later this month. All of these factors suggest more market volatility. Thus, I feel that the recent lows of around 1266 on the S&P may be seen again before this month ends.

Please bear in mind that I am firmly convinced that the stock market will likely bottom in July or August. My prognosis for a renewed bullish trend into the winter is based on a few factors. Briefly, they are:

  • S&P trailing PE ratio is back to “normal” levels from prior overvalued levels. Shiller’s inflation-adjusted PE ratio is also at reasonable levels.
  • Studies show that the second half of an election year is most often bullish
  • There is expectation for a renewed monetary stimulus program by the U.S. Federal Reserve, per Bernanke’s comments on Thursday (however vague). Something concrete will likely be announced this summer.
  • Failing to buffer the economy /markets may endanger Obama’s re-election.
  • Technical patterns are repeating themselves through a summer consolidation leading an uptrend into the fall and winter

So, you could say that I’m short termed bearish, but bullish for the balance of the year.

Hedging again

I’ve mentioned in past blogs that I like holding a few hedging positions when markets look tenuous. The VIX is my favorite way of playing the downside game. To quote my May 25th blog: “The closer that the VIX gets to its breakout point of 20, the more attractive an entry point becomes.”

On Thursday, the VIX fell to around 21 in the morning as the market rallied on hopes of stimulus plans by Bernanke that day.  I legged in with half of my desired exposure through a VIX ETF. I will buy more as/when the markets dictate. In my opinion, the markets will remain volatile for the coming weeks and one might be wise to raise their defenses again after the recent rally.

Suckers Rally tip on how to hedge investments with Vix example

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  • Hi Keith. If the Vix breaks below 20 is it likely to retrace to the previous lows in March?


    • I would say that yes, if it breaks 20, it would be a sign of further downside. However, please keep in mind my key filter for breakout verification–the 3-day rule. I blogged on the 200 day MA break a week ago by warning that a 1 day break is often insignificant. Same goes with neckline or support breaks – if it happens, give it 2 more days before selling if you own a position.
      I am of the mind that I will be still in my VIX position for a while–there’s just too much in the news that will keep it low for long.Volatility will likely rear itself again.
      Note that I have only committed 1/3rd of my allocation to the VIX ETF so far–legging in a step at a time.


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