Market Set To Rally
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After the worst week for the market since 1933, stocks are set to gap up 3% or more this morning.
As we said on Friday, the odds for a rally are high here, and that rally could be a strong one. The market is deeply oversold here, and a rally to relieve some of those oversold conditions is to be expected.
However, even if this is the bottom, some sort of retest should be expected at some point. For starters, last week's plunge in the Dow may have completed a third wave down out of a likely five-wave Elliott move (see first chart below). That means that some sort of retest, either with a higher low or lower low, is the most likely scenario after a multi-day or multi-week rally.
The one big negative is that Wall Street equity allocations have continued their march to record levels, with Goldman Sachs and Bank of America upping their recommended equity weightings to 70%-75% this morning. Those numbers are usually under 50% at major market bottoms; they were in 1998. If everyone is long, there's no one left to buy, so that remains one substantial negative in an otherwise overall positive sentiment trend.
The interesting thing about Friday's action is that the selling pressure stopped soon after the open, which is when index futures trades were settled. As we speculated last week, it appears that much of the selling pressure was due to massive losses in index arbitrage trades, so one obstacle has been removed for now. However, other pressures remain, such as massive derivative losses and foreign repatriation of U.S. funds.
We'll keep an eye on the Dow for key resistance levels here. 8500 is first resistance, and 8780-8800 is a very important level, the Dow's long trading range that was broken last week (see chart below). Support will be at today's opening gaps on the S&P and Nasdaq, and we need a close today that is higher than the open; a "gap and trap" would be bearish.
But on the S&P and the Nasdaq, last week could qualify as a retest of the October 1998 lows of 923-959 on the S&P and 1357-1419 on the Nasdaq, so add that to the list of positives for the market to build on. We'll keep a close eye on whatever form this rally takes to see if it has a chance of lasting.