Despite last weeks rally the market is flashing neon danger signs. It is like standing by a frozen pond on a warm spring day and hear cracks that sound like gunshots as the ice becomes stressed. With that said, it seems like the highest probability in the short term would be higher as the tipping point hasn't quite been reached. Still, do you want to be the one to test the ice?
After getting BP'd again last week the market ended up moving legitimately higher. After Trichet started talking on Thursday the markets did begin to roll over. Germany lost over .5% in 10 minute time frame and the U.S. futures lost 5 points. Ten minutes into the speech the German constitutional courts came out and said they would not issue an injunction against the European bailout. On a dime the markets took off and never looked back. This was very under reported here in the U.S. but I think the cause of the major rally on Thursday.
In general the news was neutral out of Europe despite a few rotten tid bits. It was enough neutral that Europe rebounded nicely and the Euro moved up. I have speculated on this blog over the last two weeks that the Euro may be near at least a short near term bottom. It is a dangerous short. If Trichet actually had something fundamentally to work with I would be buying the Euro. He is doing almost everything you want if you owned the currency unlike his U.S. counter parts who would like nothing better to destroy the dollar. The problem is the very structure of the Euro is flawed so Trichet is fighting a losing battle.
Would not be surprised at all to see a multi week rally in the Euro pushing it up towards 1.30. It is a hard bet to make and for me I don't want to participate either way but with the correlation between the Euro and U.S. equity markets (if the Euro rally does develop) that would speak to some sort of equity rally continuing. How long and how far? I don't know. The 200 day moving average sits at 1108. The 50 day moving average sits at 1146 but is falling fairly quickly. I would not be shocked to see it reach and test the 50 day moving average which by the time the market makes it up there it would probably be in the 1130 to 1140 range. That is sort of jumping the gun though because it has to get over that 1100 to 1110 area first.
In general the range of outcomes are very wide and I was shrinking the portfolio Thursday into Friday because of this until some clarity emerges. If we get the move over 1100 you would want some dry powder to add to shorts.
Like I said at the beginning, the ice is razor thin. Anything could develop out of Europe. Financial reform poses a major threat here in the U.S. and economic data continues to come in weaker than expected.
So while I would expect the highest probability is a continued rally over the next week or two I can't stress enough that fundamentally your staring into a double barrelled shotgun and the risk remains to the downside.
The biggest short term signs for the bears is that last week equities left credit behind. Credit didn't rally and this divergence won't last long. Also, volume really dried up Thursday going into Friday.