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The Larry Kudlow Recession Summer Rally

Wednesday, August 06, 2008 | 07:55 AM

in Contrary Indicators | Markets | Technical Analysis

Sometime last week, I heard my pal Larry Kudlow admit "We are in a Mild Recession."

That sent me scampering to the Modern Kudlow To Standard English Translation Guide, to see what this meant. That translates to "We are in a broad and deep recession."

Back on July 15, I suggested it was time to cover shorts for a Bear market rally, reiterating an earlier -- too early -- call for a move higher. But this ? LK admitting a recession ? This was big news. Larry is a perennial optimist, so its worth noting when he sees anything negative. In February, he broached the mere possibility of a mild recession, and last week, he saw (finally!) that a recession is here. I turned to one of my fellow fisherman/economists in Maine, and said "Larry used the R word? The negativity out there must really be tremendous. That means we are due for a counter-trend rally."

And so it was.

Let's look at what the key elements were to the Tuesday's 3% rally.

By the time we got the FOMC announcement, markets were already up 2%. After the 2:15pm announcement, they tacked on another 1%. Stock Charts has a terrific Market Summary, showing a wide range of assets. Scrolling thru that list of sector gainers and losers, we see Airlines up an astonishing ~10% on the day (9.60%), Banks gained nearly 5.5%, Brokers 4.6%, all the while Gold dropped 5%. Gold the metal fell $21.80 to break $900 ($886.10) losing -2.4% on the day.

And Crude oil, the key to the recent gains, broke below $120 -- losing $2.24 (1.84%) to close at $119.17.

If I told you a year ago that Oil dropping below $120 would ignite a 3% rally, you would have thought me daft.

Aside from the Crude spark, a few other items were noteworthy. Markets were fairly (though not very) oversold. Richard Russell tracks this condition via his "PTI" index. It closed Monday at the lowest reading since mid-May of 2007

Confirming that oversold condition was Lowry's Selling Pressure Index. It closed at a multi-year high. This suggests heavy selling into the market.

Also of significance: ~~Yesterday was the first 90% day we have seen June 26th. On the NYSE, there were 2526 advancers and 862 decliners~~. The aforementioned Richard Russell notes that the up volume was 91.4%. Paul Desmond of Lowry's states that bottoms are usually accompanied by a series of 90% up and down days. The absence of 90% Days is very unusual, especially given the Uptick Rule has not been in place. Since this was the first 90% day in 2 months, that makes it noteworthy.

(UPDATE: AUGUST 6, 2008 10:42am: ~~According to my trusty Bloomberg terminal, yesterday's Total NYSE Volume was 1227.05; the Up Volume was 1149.09. That makes for a 93.6% up day by my math~~).

UPDATE: AUGUST 7, 2008 6:42pm: This data was premature. See this for more info.

Back on July 15, the Dow made a closing low of 10962.54 -- the lowest Dow close since July 2006. Yesterday, it closed at 11,615.77. So we have yet to run even 1,000 points. Hence, despite the turmoil, this is still early in the rally's lifespan.

~~~

On the other side of the ledger, we have Lowry's Selling Pressure Index at those highs. Normally, it declines well ahead of a market bottom. The new high in this Index does not equate with the thesis that we're near a market bottom.

Further, Paul Desmond tells me that since we did not have any 90% Down Days close to the mid-July low, we have not seen the required selling exhaustion for a major bottom.

Further, its been 3 weeks since the lows, and we did not have a 90% Upside Day quickly after the rally began. Paul's prior work on market bottoms suggests that almost always accompanies major market bottoms. He views the recent rallies as primarily short-covering by hedge funds rather than accumulation from investors. I agree.

Bottom line: A classic Bear Market rally, one that could run for a few more weeks. My best guess is to 12,250 - 12,500.

Previously:
Kudlow: Possibility of a Mild Recession (February 2008) http://bigpicture.typepad.com/comments/2008/02/kudlow-possibil.html

Wild Times on Wall Street (July 16, 2008) http://bigpicture.typepad.com/comments/2008/07/wild-times-on-w.html