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Why the 'pain trade' may still be higher

Despite an impressive rally, the "pain trade" is still likely higher.

My, what a difference a few days make. I left for a trip to Panama and Colombia on Feb. 24. The rally from the Feb. 11 low was still underway, but it all had a very tenuous feel to it.

But since then we have entered a new, higher phase, which you might call a "Goldilocks window."

Here's what is underpinning this Goldilocks window:

1) Economic data has been generally better than expected, and the fear of a recession has greatly receded.

2) Commodities appear to have put in a bottom; oil has rallied more than 35 percent since the Feb. 11 low, and traders have dramatically reduced short positions. This has a) positive implications for earnings, particularly for energy and materials, which have led the rally; b) positive implications for credit in general; c) eased some of the worries about financial exposure to the energy sector from banks; and d) decreased worries about an out-of-control deflationary spiral.

Other commodities have rallied as well. As China announced cuts in production capacity and layoffs in its five-year plan, iron ore is up roughly 16 percent today to its highest level since June, one of its biggest one-day rallies ever.

3) The yield curve has steepened a bit, which is a positive for Financials. The Financial ETF is up 13 percent from its February low.

4) The market has come to strongly anticipate that the Federal Reserve will lower its expectations for rate hikes at its March 16 meeting, likely bringing down the number of hikes from four to two, or at most three. Vice Fed Chair Stanley Fischer's speech today at the NABE will be widely watched, since it's the last opportunity for a Fed official to speak before the Fed meeting.

The European Central Bank is also likely to unveil additional stimulus this week, including (possibly) even deeper moves in sub-zero territory, but it will almost certainly expand its bond buying program, which is currently at 60 billion euros a month, and likely extend the duration of the buying, which is currently set to expire in March 2017.

5) A huge emerging market rally ensued as commodities rose last week. The iShares Emerging Market ETF is up 9.2 percent, Market Vectors Russia ETF rose 11.7 percent, the iShares South Africa ETF jumped 12.9 percent,iShares Brazil Capped ETF increased 24.8 percent, and even the iShares Colombia Capped ETF climbed 8.4 percent.

6) The S&P 500 has seen a series of "higher lows and higher highs" over the last month. Days of heavy volume on down days with little volume on up days have now flipped.

On Friday, composite volume for all stocks trading was 10.4 billion shares, its highest level since the lows on Feb. 11.

The good news is the S&P has retraced roughly 60 percent of the losses since the recent high in November 2015, when we went from roughly 2,115 to 1,810 on Feb. 11. According to our partners at Kensho, once the market retraces 60 percent of its losses following a bull-market correction, "it generally keeps going higher in the months that follow."

Since 1980, there have been eight other bull market corrections. During those episodes, when the S&P retraced at least 60 percent of its losses — as of Friday it had retraced 60.8% of its losses — it was positive 88 percent of the time three months later, returning a median of 9.62 percent.

Still, there is obvious resistance around the 2,000 level for the S&P 500. The 200-day moving average is 2,023. Many feel it is tough to be more constructive at this point.

"At this price, the market is a weak Buy, but a strong Hold," one trader said.

And this skepticism is again the market's best friend. Most continue to believe that this is a bear market rally in what promises to be a long and difficult year, though even the skeptics are surprised by the strength. Now the bears are arguing that within a month or so we will be entering a seasonally weak "Sell in May and go away" period. It's a weak argument, but the stock market participants — like the general electorate — is in a sour mood and not inclined to buy a bottom.

That's why the "pain trade" is likely higher.

  • Bob Pisani

    A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

Wall Street