Santoli: Deja vu rally could prove sturdier this time

Published Sun, Mar 20 201610:49 PM EDT

The current ferocious market rebound might seem to have come out of nowhere, but in a way it came straight from last fall: The advance looks so similar to the rally that kicked off the fourth quarter of 2015 that the crucial question now is whether this run will fizzle in matching fashion. First, the striking resemblance, then the subtle differences. The surge that began Feb. 11 has carried the S & P 500 12 percent higher in just over five weeks — the exact rise in the five-week sprint from Sept. 29 to Nov. 3. In each case, the rally began after a second panicky trip to a multiyear low within a month's time (August and September, then January and February). Source: FactSet After the five-week surge in both instances, the CBOE S & P 500 Volatility Index , or VIX, collapsed to just over 14, while the forward price-to-earnings multiple of the S & P recovered to 16.7 in early November, and 16.6 today. Junk bonds rallied strongly each time, as did oil prices. Hedge funds caught wrong-footed by violent macro moves were near the center of the carnage and their hasty retreat was a feature of both rallies as short-covering and repositioning drove the action. Of course, the autumn recovery was short-lived. Stocks entered November in an overbought condition, and spent the rest of the year trading sideways to down in a choppy rhythm as the world fitfully awaited the Federal Reserve's first rate hike in nearly a decade in mid-December. And, of course, the dam broke in January, as global investors feared a Fed "policy error" and China's inability to avoid a hard landing. Read More Pro Talks: Liz Ann Sonders on fate of bull market Is the present rally doomed to a similar fate, or might the market hang on to a good portion of its gains a bit longer this time? On a short-term basis, it would be surprising if stocks didn't back off a bit. The rally has been running pretty hot, and various gauges show it again to be overbought, some 8 percent above its 50-day average, a level that means a pullback of some sort should be expected. And, as noted, the market's valuation has not much improved after its wild drop-and-bounce act. Corporate-profit estimates continue to ebb, leaving the earnings path the ultimate key to whether stocks can summon more fundamental energy. Credit conditions have firmed nicely, with risk spreads on junk bonds compressing dramatically, though these spreads do remain nearly a percentage point wider than on Nov. 3. Read More The nagging problem with the stock market's rebound Yet a fuller check of the market's vital signs reveals some positives that work in favor of this rally proving sturdier over time. These are the broader nature of this rebound, a more sober mood among investors and a Fed more in tune with market expectations. For the first time since 2013, more than 90 percent of the S & P 500 stocks are above their 50 day average, a testament to how inclusive the advance has been (and how comprehensive the collapse that preceded it). Historically, this measure of widespread strength has tended to be followed by higher prices in subsequent months. In certain respects, for all the similarities of these two rallies, the character of the market this year is in sharp contrast to the 2015 tape. Whereas one year ago the talk was of levitating indexes led by an ever-narrower group of stocks, this year the indexes are flat, yet the majority of stocks up on the year. Investor psychology is in a healthier state now than in early November. The various surveys of mood, options activity and institutional-investor positioning have shown an easing of fear but not as much of a swelling of optimism or greed as we saw last fall. Back then, the confident talk was of a near-certain "year-end rally." Today, suspicion of the rally is more common. Keith Lerner, chief investment strategist at SunTrust, frames it like this: "The rally … caught many investors off guard. Investor positioning is still somewhat defensive given the size of the rally — cash levels are still high, hedge fund equity exposure remains low, and investor sentiment is largely subdued. ... This suggests near-term pullbacks will be contained." The Fed's statement last week halving its projected number of rate increases to two from four over the rest of 2016 was little more than a ratification of the bond market's prevailing view. Yet every time the central bank simply assures the market that it is not on some dogmatic, preset course of "normalization," the relief tends to last for a while. None of this should be interpreted as an all-clear signal. The rally has not definitively banished the threat that this wide, volatile range could be a treacherous, bear market in the making. Retail investors have rushed headlong into junk bond funds just weeks after barreling out, and this money is usually hotter than it is smart. And the massive surge in oil prices that have bolstered the equity recovery has come awfully far and fast, so stocks might have to absorb a nasty pullback in crude before too long. An awful lot of bearish sentiment and indiscriminate selling set up this rally, and it's unclear whether it's all been burned off, even as the S & P 500 has climbed to within 5 percent of its May 2015 high.

A trader works on the floor of the New York Stock Exchange.

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First, the striking resemblance, then the subtle differences.

The surge that began Feb. 11 has carried the 12 percent higher in just over five weeks — the exact rise in the five-week sprint from Sept. 29 to Nov. 3. In each case, the rally began after a second panicky trip to a multiyear low within a month's time (August and September, then January and February).