Bulls Go on the Offensive

Tuesday's rally was fueled by extensive hedge fund buying of the indices and the index-based exchange-traded funds. Traders were responding to fear and caution in the market, evidenced by extreme readings of defensive bets on puts relative to optimistic call-buying.

At one point intraday Tuesday, the Chicago Board Options Exchange's total put/call ratio (including both the equity and index puts and calls) reached 1.45. A put/call ratio over 1.0 shows investors are making more bets the market will fall rather than rise, which is unusual given the market's long-term upward trend. The level of fear such a high put/call number suggests is often viewed as a contrarian indicator.

Technically, the market needed a breather from intense selling pressure. But the fundamentals, or the economic data, on Tuesday didn't exactly support the rebound.

Fundamental Matters

Productivity in the fourth quarter was revised down to 1.6% from an initial estimate of 3%. More significantly, unit labor costs jumped sharply to 6.6% in the quarter and 3.4% on a year-over-ear basis.

The 6.6% pace is the fastest in six years. While some economists explain away the increase as year-end bonus season, the tight labor market and upward-creeping wage inflation have been key concerns for the Federal Reserve. Higher unit labor costs will help keep the Fed attached to its tightening bias.