Not Much Follow-Through

What a strange week this has been. Tuesday's sharp sell-off continued on Wednesday but a late-day rally brought a dramatic reversal. The Dow swung from a 326 point loss to a 298 point gain, making the daily range a remarkable 625 points on very heavy volume. Bullish analysts were quick to pronounce a bottom. Then this morning we learned that French bank Societe Generale had been victimized by a "rogue trader" who somehow managed to hide over $7 billion in stock index futures losses from his managers. Now it appears that Monday's drop in European markets may have been sparked when SocGen began unwinding these previously unknown positions.

It is troublesome to think that a major bank, indeed one of the world's largest financial institutions, just didn't notice that one of it's own staff had hidden away billions of dollars. The incident begs the question of how many other rogue traders are doing similar things at other banks. This can't be positive for the financial sector - which in fact was unable today to repeat Wednesday's snap-back rally. Today's gains in the major benchmarks were muted, at best, and not characteristic of a market that is ready to move significantly higher. This does not necessarily mean that further declines are coming. It is at least equally likely that we are entering a period of base-building, during which markets will be choppy in preparation for the next major move.

Our relative strength rankings continue to show a bias toward economically defensive sectors like health care and utilities. The gains in financials, real estate, and homebuilders over the last few days were impressive, but must still be regarded as short-term rallies from deeply oversold conditions. This week's gain has brought those sectors roughly back to where they were 3-4 weeks ago. The lack of follow-through in Wednesday's strongest sectors and generally low volume today suggests the major trends are not yet ready to change. Energy and materials bounced back as well, and it remains to be seen if they can continue to recover.

For the moment, then, the picture is cloudy. We may be on the cusp of a major trend change, but it is far too early to say this with any degree of confidence.