Stocks jumped broadly higher Wednesday, giving the U.S. market its biggest two-day advance in more than four years, just two days after registering its first 10 percent decline in more than four years.
The Dow Jones industrial average surged 331.01 points, or 2.5 percent, to 13,289.45, the best one-day gain since April 2003. In the last two days the Dow has climbed 546 points.
Veteran stock market watcher Michael Metz said the market is “manic-depressive.” This week it’s been depressive-manic. Either way, traders and analysts say the bipolar stock market has by no means been cured and probably remains unfit to be discharged into the general population.
They also say the single issue that hovers over the bulls and bears is whether one of the world’s major banks is going to fail in the wake of Wall Street’s subprime mortgage debacle. Conflicting facts and opinions about the economic outlook pale in comparison.
“The market is being jerked around by what’s going in the financial area,” Metz said. Every other consideration, including heavy betting on Federal Reserve interest-rate policy, centers on fears that imperiled banks will quit lending to consumers and businesses, he said.
Traders said a wave of optimism about major banks began Tuesday, after the oil-rich nation of Abu Dhabi disclosed plans to invest in Citigroup, the biggest U.S. bank.
On Wednesday Donald Kohn, vice chairman of the Federal Reserve, lifted spirits by declaring that the Fed needs to counteract the “stigma” of an emergency in the world banking system.
“The Fed is going to ease [interest rates], because they are really determined to get the banking system in better shape,” Metz said.
“It really has nothing to do with anything else,” he said. “The banking system is still very fragile. It has nothing to do with the economy or retail sales. It’s will the system implode?”
“The swings are very large and very quick,” said Alfred Kugel, chief investment strategist at Atlantic Trust. “Tuesday was Abu Dhabi day. It changed all the mind-set. The people who had been selling aggressively on Monday afternoon had to reverse course. … Financials are the bellwether now. I used to think it was General Electric. Financials and the health of that industry are probably the single most important thing you can watch.”
In that light, if oil-producing nations awash in dollars are hunting bargains in U.S. bank equities, investors everywhere can take heart, he said. Indeed, in the last two days GE shares have climbed 4.7 percent, while Citigroup has jumped 8.7 percent.
But the drumbeat of weak housing data did not let up this week. Wednesday’s reports on economic conditions by the 12 Federal Reserve district banks indicated spillover from the housing/mortgage slump to retail sales, noting “pessimistic” outlooks for the holiday shopping season.
Still, the rebound of the last two days reflected optimism from other quarters. By most accounts, post-Thanksgiving retail sales in stores and online were better than expected. Oil prices have retreated from nearly $100 a barrel in futures trading, ending Wednesday at $90.62.
Given those upbeat developments, it’s worth noting that healthy rebounds after stocks have dropped by 10 percent are not unknown. Seven times since World War II stocks have bounced at least 2 percent on the two days after hitting a 10 percent decline, according to Bespoke Investment Group.
But in four of the previous periods, stocks resumed their decline soon after. In 1998, for example, stocks suffered two 10 percent corrections, despite a nice rally after the first one. Hedge funds and other professional traders responsible for the recent market swings remain poised to sell.
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“This risk is continued volatility,” said Jim Herrick, director of equity trading at Robert W. Baird in Milwaukee.
“Just because we’ve had a move up and a V-shaped formation doesn’t mean we won’t go back and test the lows. The big risk, particularly for the small investor, is they get caught up in the days of these strong updrafts only to have another shoe drop.”
The recent oil futures market provides a timely analogy to the current volatility in stocks, said Al Greenberg, head floor trader at the Chicago Board Options Exchange for BNY ConvergEx Group.
Short-term traders, including many hedge funds, typically have an exit strategy when they take a position. Recently, many traders bet on oil reaching $100 a barrel.
When it becomes costly to hold that position over many days, as oil flirts with $100 but doesn’t reach it, traders bail out en masse, he said. Similarly, target lows for traders betting against Citigroup and the stock market as a whole became harder to maintain as a bit of good news emerged in the last two days. Traders who had sold short, or sold borrowed shares, bailed out by buying back their positions.
“We see this coming through our desks,” Greenberg said. “They throw in the towel.”
Evidence of this nervousness is reflected in swelling volumes for options on the CBOE volatility index, known as VIX, Greenberg said. The index tends to increase in value when the stock market declines.
A favorite move of late has been to buy call options on the VIX, which give the owner the right to buy the index at a stated price during a stated period.
“They’re buying VIX calls. They see the market going down,” Greenberg said. So far this month average daily volume in VIX options is greater than it was in August, the last time the stock market rattled investors.
Alexander Paris of Barrington Research Associates doubts that the bounce of the last two days will last. “I definitely don’t like this,” he said.
The market needs to reflect the reality of the weak economic outlook, he said. Rallying on Arab investments in Citigroup and hopes for easier money from the Federal Reserve ignores the prospect that the economy will sputter for the next six months, he said.
Moreover, he said, “I would prefer that the market keep coming down. I was already starting to nibble. I don’t think there’s going to be a significant recession.”
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