Bear market rally or the beginning of a bull?

That's the $64,000 question. Today's market rally, ignited by Wells Fargo announcing much better than expected earnings, did much to calm investors along with positive statements made recently by other major banks. (Um...now why did they need TARP money?) Wall Street is beginning to get a handle on where the situation stands (at least for now) in terms of predicting future earnings. This decrease in uncertainly is reflected in the fall of the VIX, the market volatility index, which gapped down over 4% on today's open and closed at 36.5. A trade below 36 will close last September's gap, adding further fuel to the rally.

Technical bullish signs
Bullish indications are starting to appear, but some of them contain mixed messages. Here are a few of the more notable signals:

1. Rising from historic lows (0.02!), the buy/sell ratio (BSR) finally turned bullish on April Fool's Day. A BSR greater than 1 indicates more buyers than sellers and is a bullish sign; a BSR less than 1 is a bearish sign indicating more sellers than buyers. (Actually, the BSR is a pretty decent timing signal all by itself and an investor could do quite well using it in that way.)

2. The number of new yearly highs is increasing. From just one or two stocks (other than ETFs) hitting the daily highs list a couple of months ago to nearly 30 today—that's a pretty decent jump!

3. Many of the major markets are breaking out or are on the verge of it. Before I toss my cape into the bull ring, however, I'd like to see the Dow Transports close above 300 (it closed a hair under it today). The Transports are considered to be a leading indicator of market direction. If that index can close above 300 and if the VIX drops below 35, then I'll start sliding into long positions.

4. The financials are in an uptrend. Not surprisingly, the banks did especially well today. The Regional Bank Holders, the RKH, and the Financial SPDR, the SKF, both made convincing break-outs (up 22% and 15% respectively) albeit on normal volume. The lack of volume conviction raises some skepticism about the health of this rally, although the relatively light volume could be due to people taking off early for the Easter weekend.

Summary
In summary, optimism seems to be growing but the mixed technical messages suggest that the Street is not quite convinced that this rally has long-term legs. A lot of uncertainty has been removed, to be sure, but that doesn't mean there aren't more skeletons in the closet waiting to be rattled. Furthermore, I'm not sure anyone can accurately predict how continued high unemployment, rising credit card defaults, and increasing real-estate foreclosures will affect the economy.


An update on the VIX: I was wrong
In an earlier blog, I stated that I didn't think the market would reach its bottom until the VIX reached another top. In retrospect, that was probably an erroneous assertion. When the VIX was hitting its previous two tops last autumn, the market was in chaos and nobody knew anything. The credit tsunami hit everyone by surprise and even Wall Street wonks were mystified by credit default swaps and credit default obligations. If nobody understood them, how could anyone accurately predict what the fall-out of the blow-up would be? And what would be the fate of the financial institutions who held them? At that time, confusion and fear reigned supreme.

Today, the situation is different. The mortgage meltdown is beginning to solidify. The government has kept its word and has poured substantial equity into the financial system. The Street is beginning to get a sense of where things stand. All of these factors are allaying investor fear which in turn is causing the VIX to drop and the market to rise.

The March bottom could well be the bottom after all. Most likely stocks were greatly oversold and the recent rally could be nothing more than a return to more normal valuations--not the beginning of another bull market. I'm not sure anyone can tell the difference except for maybe Larry Kudlow.

In short, I'll take my lumps and admit my analysis was wrong. I looked at things purely from a technical standpoint and didn't take into account the sea change in investor perspective. Hey, if I were always 100% accurate I'd be playing yacht tag right now with Larry Ellison.


Channeling Stocks Update
For those of you who are still following the Channeling Stocks Portfolio, today was another bad day for most of it. Three short positions were closed: AMG, AMTD, and NBL. One long position, OSIP, was added. An updated table will be posted this weekend. Tomorrow I'll finish up Tuesday's article on calculating portfolio returns.