The Market is Prone to Bounce - 8/21/2011

Back in May 2011, I shared my view to two of my friends that the US market would enter a turbulent period after it hit the 52 weeks high. My prediction was based on many clouds gathering at same time: high oil price (~$118/barrel), Greek crisis and its bailout debate, the US debt ceiling debate, the economy was losing momentum but the Fed still insisted to end the QE II. Moreover, the commodities mini crash at the beginning of May foretold me the storm ahead.

After almost three months of selloff (~17%), I now see the current storm may be passing and the sunshine may be ahead of us based on the following factors.

1. The oil price has dropped about 30% since then, which is equivalent to a mini tax cut to help the businesses and consumers.

2. Despite the debt rating downgrade by the S&P, the market disagreed with the decision by pushing the 10 years Treasury yield to the record low at around 2% from 3.3% in May. The low rate will definitely help the economy.

3. The debt ceiling debate was behind us. President Obama can now put his focus on rejuvenating the economy. He will outline his new plans and policies to help the job market and the economy after the Labor Day.

4. The Fed has been and will be very aggressive to fight the downturn. They first committed to keep the zero rate until the second half of 2013. Then, they hinted that they would do more to help the economy. New pro-growth action(s) is/are expected to be announced at the end of this month.

5. The fear index (VIX) has jumped to a historic high level (>40), which signals that the market may be about to reverse its course.

6. Companies are still making huge profits and amass mountains of cash. If the anticipated new pro-growth policy is enacted along with the expected Fed’s action, their profitability will continue.

7. European governments are believed to do whatever they can to contain their debt crisis, at least for the short-term.

The main risk is if the European and the US governments do not take any action, but it seems very unlikely given that they have done a lot to help the economy and the market since the financial crisis. It has no reason to forgo their prior efforts to let the world economy back to recession.