Don’t Trust This Stock Market’s Positive Moves

Last week’s final 20 minutes of trading produced bullish sentiments and articles, even though the rest of the highly volatile week came up short.

That optimism produced a groundswell of buying interest this morning (Monday, January 31), especially among the poorest January performers. This wholesale jump-on-the-bargains strategy is the result of meshing sudden relief-optimism with the belief that the further a stock fell, the higher it will rebound.

The two graphs below exhibit that thinking by correlating two performance results: Year-to-date through last Friday vs Monday morning.

The risk: A “bull trap” at work

This TD Ameritrade summary explains a bull trap well:

“A ‘bull trap’ tricks investors into thinking a stock price decline is finished and that it’s a good time to buy

“Bear markets and steep selloffs have often been followed by temporary rallies that turned out to be bull traps”

Therefore, view the combination of last Friday’s final bump and today’s action with skepticism. It could be a contrarian sign that the market’s decline is not yet over.

Three confirmations: Feelings, longer-term market position and all-time high stocks

Everybody, even experienced professionals, are susceptible to the stock market’s actions producing misleading emotions. So, how did you feel over the weekend following Friday’s rise producing an upside week?

Personally, I felt bullish – that this could be the end of the selloff I’ve been writing about for many weeks. I thought that feeling could be appropriate because there have been recent articles citing the 2022 concerns, so perhaps the risks were priced in now.

Next, I looked at the stock market’s longer-term position. While 2022 has been a bust so far, the decline has yet to make a real dent in the previous, extended run-up. The charts below show the period from July 1, 2020 (after the Covid selloff and rebound). Clearly, there’s plenty of room to adjust downward if the 2022 conditions warrant a change in valuations.

Last, an opportunity check I always make is to see what stocks have broken into all-time high territory. Friday’s short list was an excellent test because it should show leaders of the new bull market run – if last week was, indeed, a selloff bottom. Alas, while five stocks looked promising, there was no oomph to be found. One-by-one, I removed them, ending up with no opportunistic buys.

The bottom line: Today’s nice-looking rises are likely part of a bull trap

When will we know for sure? Barring any surprise events, we are entering the mid-month period of the first quarter that will be light on new data – earnings (with company outlooks), economy readings and Fed-talk. Inflation and supply issues might taper off since the first quarter always has the lowest level of GDP (actual, not seasonally adjusted). Covid, too, may be a lesser issue. Therefore, the stock market could rise, distancing itself from the January selloff.

And then comes March, the beginning of the new Fed-created financial trend. Also, analysts will be busy trying to discern the first quarter’s effects on business revenues and costs. Of particular interest will be each company’s “pricing power” – the ease with which they can raise prices to combat rising costs and boost real (inflation-adjusted) revenues and earnings.