It looks as if the bulls are back in the short term. However, I have a feeling that the rally will be short lived, before we retest that 1,100 area. I suspect that the strong supply zone around 1240 to 1260 on the S&P should contain the advance, but I am not the best short term trader. History shows that whenever we had a crash of this magnitude with a high VIX spike, we almost always retested the panic lows. This was true in 1990, 1998 and 2010 Note: In late 2001, we did not retest the lows, so therefore next year the market went much much lower down into the 2002 bottom.
I did not include 1987 and 2008 in the crash analogue above, because the price has stopped crashing and we have stabilised somewhat. We could now drift lower, but I do not think we are repeating 2008. Money Market Rates seem to be stable as well, even though CDS have been rising. This is not a huge corporate crisis (private sector) like in 2008. The bad fundamentals are now on the public sector balance sheets, as governments struggle to pay of their debts. But unlike private sector, the public sector has the ability to create money out of thin air and print it. This should benefit commodities, just like always throughout history.
Finally, there have been a lot of worries about a potential recession and the impact on corporate profit margins as well as earnings. I have addressed those worries quite well in my previous posts (What Are The Chances Of A Recession? - Part I and also What Are The Chances Of A Recession? - Part II). Finally it has come to my attention that there is now a huge divergence between the Treasury 10 Yr Break Evens (TIPs vs Treasuries Spread) and the S&P Implied Earnings Growth. It seems as if investors are more bearish on prospects of earnings growth rate today, than they were at the depths of the financial crisis in 2008 and into March 2009.
However, investors aren't as worried about deflation according to the 10 Year Break Even spread. Something doesn't add up. Either the earnings prospects will improve from very pessimistic levels or the CPI will start to deflate further, dragging down economic growth. I guess the super bears will argue that deflation is on its way, but they are always saying that. I would think that the current pessimism on earnings growth is deviating too far from its long term trend. I would also argue that the only asset class that has confirmed deflation and moved lower than the March 2009, is the 10 Year Treasury Note Yield. Crude Oil, Copper, Corn, Wheat, S&P 500, Emerging Markets, DAX 30, Nikkei 225, Euro, Aussie Dollar, Canadian Dollar, British Pound, Junk Bonds, Corporate Bonds, Emerging Market Bonds, etc, etc. Not one other asset class is lower than March 09. Not even the 30 Year Bond Yield has confirmed this move. Therefore, I would argue that deflationist are in the wrong as it is highly unlikely that one asset class is right, and the whole financial market is wrong.
Summary: While we could rally somewhat more from here, I expect a retest of those lows set on August 09th at 1101 on the S&P 500. September is typically the worst month of the year seasonally, so I would be surprised if we had two good Septembers in the row (remember September 2010?). Having said that, I think we are now closer to the end of this deflation trade (correction), which started earlier this year as the Fed gets ready to print even more money during their September FOMC meeting. I still recommend investors stick to commodities, instead of buying beaten down Financial Sector. As previously stated, I will be buying Agriculture and Energy, and staying away from Safe Havens like Treasury Bonds... and maybe even shorting them soon!