Anatomy of a Rally

Monday, July 07, 2003 | 09:55 PM

Anatomy of a Rally: The running of the Bulls in Pamplona – an annual rite of the San Fermin festival since 1591 – arrived a mere quarter after the Wall Street Bulls began a run of their own; Like their human counterparts, these Bulls have been known to maim and occasionally kill unwary tourists who decide – often belatedly – that they want to get in on the action.

With the most Bullish quarter since 1998 behind us, we thought we might review how we got here: In early March, the Q1 sell-off accelerated, as War fears heated up. Uncertainty, Orange Terror alert, duct tape warnings, all combined to create an atmosphere of panic and a retest of the October lows. During the market’s fall, few other than true contrarians were buyers of investors’ fears. Along with this group were savvy shorts who were covering their open positions. These shorts provided a floor for the market, visible in the March 12th reversal day; After making a new intra-day low, the market ended up closing at the high of the day – the start of a short covering rally. A few days later, the Nasdaq crossed over its 200-day moving average, creating a new round of short covering.

A Presidential address a few days later made it clear that war was mere days away. Those who anticipated a replay of the 1991 Gulf War rally bought in advance of the actual invasion. But what kept the rally rolling were the “deep value” players. Tracking primarily company P/Es, these fundamentalists bought stock – but only at their prices.

Next up were the Technicians, who had seen the downtrend broken on their short-term charts, with strong A/D line. This also caused another round of short covering. By March’s end, gains of 15% led to an overbought condition – and a 50% subsequent retracement. In April, the War was going better than expected; By late April, the SPX moved over its 200 day again, and this time, stayed there. Once the market surpassed March’s highs, the momentum traders arrived in force. A tax cut geared towards the capital markets (dividends and capital gains) was their reward. That begat a new leg up in the markets, with many stocks were making new 52 week highs.

Soon, many mutual fund managers found they were underinvested. In order to catch up with their benchmarks, they bought the highest beta stocks they could. They all piled into the market at mostly the same time. Their aggressive purchases helped force the Nasdaq even higher.

Finally, the individual investor arrived, along with their strong mutual fund flows and high % Bull/Bear sentiment. This group’s belated buying started in late May/early June, and has continued right up to the present day.

That leaves me with a final thought on Pamplona: After the Bulls have had their way with the weak and the slow, they are led to the ring, where, they are methodically stabbed, bled, and slaughtered; One only hopes their Bullish human counterparts don’t suffer the same disappointing fate...

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Quote of the Day: "A man should never be ashamed to own that he has been in the wrong, which is but saying that he is wiser today than he was yesterday." - Alexander Pope

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