Where now for the 2016 rally?

The violent downward moves seen on 9 and 12 September have caught many investors on the hop, but is this the sign of something bigger or just the latest dip to buy?

Data on screen
Source: Bloomberg

The first week of September really lulled investors into a false sense of security, broadly replicating as they did the rangebound trading of July and August. Events billed as vital, such as the European Central Bank meeting, were actually relatively quiet in terms of market reaction. Instead, it was a speech by Eric Rosengren, not usually the most closely-followed Federal Reserve member that was blamed for the sell-off.

In reality, the market’s tantrum extended beyond mere unhappiness with poor Mr Rosengren. The Fed continues to threaten a possible move in rates, while the European Central Bank has held off more stimulus and the Bank of Japan is seemingly gripped by policy paralysis.

Short interest has been steadily declining since its peak in the first-quarter of the year, increasing the risk that everyone is on ‘one side’ of the trade (ie the long side). When the reverse happened in Q1, the rally caught everyone off guard, and continued as investors (both institutional and retail) continued to short the rally. Markets have enjoyed a powerful rally off the lows seen after the Brexit announcement, and complacency ruled in rangebound US markets. Buying the lows in a rangebound market is usually a great strategy, until the final dip which turns into a sell-off.

This dip could continue for a few more days, but as volume returns and bargains emerge, I would not be surprised to see a fresh rally. Indices have recovered spectacularly since the February lows, and are still within easy touching distance of all-time highs in the US. The charts would back this up. 

The S&P 500 has already begun to recover, and has not even touched the uptrend line off the February lows. Admittedly it was heavily oversold intraday, so we will need to watch 2150 for signs of bullish nervousness. 

The FTSE 100 gained 26% from its February low to its September peak. It fell 4% from peak to trough over the last few days, but has held above 6660. Here we could see a dip all the way to 6200 and still be above the February uptrend line.

In short, this pullback was not unexpected – we have seen these before and will probably see them again. The relentless buying of early 2016 helped prevent a bigger drop, stabilising markets after a sustained pullback. We now need to see equity inflows improve, as this would provide the real bullish momentum. 

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