Bulls Go on the Offensive

A 'technical bounce' proves formidable but faces a critical fundamental test Wednesday.
Author:
Publish date:

Tuesday's bounce makes a lot of sense from a technical perspective. But proof of whether it's a "dead cat bounce" or the start of a true rebound won't come until Wednesday, when more fundamental evidence is in hand.

"I think we rally right into the beige book, and then we'll see what this

bounce is really made of," says Alex Grace, a trader and hedge fund consultant.

There's no question that Tuesday's rally was much stronger than any of the tepid advances since last Tuesday's plunge. After stabilizing trading sessions in Asia and Europe, the

Dow Jones Industrial Average

surged 1.3% to close at 12,207.59. The

S&P 500

jumped 1.6% to close at 1395.41, its largest day gain in four months, and the

Nasdaq Composite

finished up 1.9% to close at 2385.14 -- its best day since October.

On the

NYSE

, 80% of stocks were advancing --- the most since July last year, while 78% of Nasdaq stocks were climbing. Meanwhile, upside volume topped 90% in both venues.

All 30 of the Dow's stocks advanced, led by 2% or greater gains in

Alcoa

(AA) - Get Report

,

American Express

(AXP) - Get Report

,

Citigroup

(C) - Get Report

,

Disney

(DIS) - Get Report

,

IBM

(IBM) - Get Report

,

J.P. Morgan Chase

(JPM) - Get Report

and

Altria

(MO) - Get Report

.

Among the most active on the Nasdaq, large-cap tech companies

Apple

(AAPL) - Get Report

,

Intel

(INTC) - Get Report

,

Cisco

(CSCO) - Get Report

, and

Microsoft

(MSFT) - Get Report

added over 1% each.

Shares of

eBay

(EBAY) - Get Report

,

Oracle

(ORCL) - Get Report

and

Brocade Communications

(BRCD)

each jumped more than 3%.

"This is a solid bounce," says Todd Leone, head of listed trading at Cowen & Co. "But it may just be a dead-cat bounce. Much of this is technical."

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.

The 10-year Treasury note sold off a modest 7/32 to yield 4.53% in reaction, but bond investors were more fixated on the growth story, which took a blow from a weak factory orders report. Factory orders declined 5.6% in January, after a 2.6% increase in December. Analysts had expected orders to fall 4%.

"When bond traders see evidence

of economic moderation happening, they want to turn that into a recession bet," says T.J. Marta, senior fixed-income strategist at RBC Capital Markets. Marta notes that this has been traders' mindset throughout this rally -- to embrace negative news about economic growth and price in future rate cuts.

But Tony Crescenzi, chief fixed-income analyst at Miller Tabak and

RealMoney.com

contributor, says the weakness is "old news" because durable goods orders are 55% of factory orders, and the market already knew that was exceptionally weak.

Elsewhere, pending home sales dropped 4.1% in January, more than the 1.2% decline analysts had expected.

But it seems investors still are paying more attention to words and psychology these days vs. fundamental data. Soothing words from U.S. Treasury Secretary Hank Paulson in Tokyo helped spark a rebound in the mortgage-lending sector. "Credit issues are there, but they are contained," Paulson told reporters, according to newswire reports. He said the U.S. financial industry will not experience "a big impact" from the subprime mortgage meltdown.

New Century Financial

(NEW) - Get Report

regained 10.1% after a disastrous 70% decline Monday.

Accredited Home Lenders Holding

(LEND) - Get Report

gained 9.5% and

Countrywide Financial

(CFC)

added 4.7% on the day.

Private lenders were further aided when Fed Chairman Ben Bernanke urged Congress to bolster regulation of government-sponsored mortgage giants

Fannie Mae

and

Freddie Mac

, which nonetheless rallied 3.2% and 1.2%, respectively.

Wednesday's beige book will help square off for traders whether the economy is slipping further than Bernanke says. If the report reveals strength, the market could keep rallying. If it reflects the weakness investors fear, the sound of a cat falling back to earth will be easy to discern.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

here

to send her an email.