Choppy day ends with big rally as investors bet on bottom

Kevin Pendley | Oct 16, 2008 4:30pm EDT | Comment

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Small-cap stocks climbed to an impressive rally Thursday, quickly putting aside any downward momentum from Wednesday’s historic collapse. Investors were picking through the rubble for bargains, and also appeared to be testing the waters for a potential bottom. Traders had to endure choppy waters as the market traded more than 3% on both sides of the ledger, buffeted about by mixed economic data. The Russell 2000 (NYSE:IWM) closed up 34.46, or 6.86%, at 536.57, rejecting an intraday slide to the second-lowest point in more than five years to notch the third-largest one-day gain of the year. The Russell is now off 30% for 2008, while the Dow is down 32% and the S&P 500 is off 35%.

One encouraging element of the recovery move today was that small caps paced the move over the Dow and S&P 500 – even when the market struggled in the midday time frame. In addition, today marked the most solid chart action that we have seen since this whole collapse kicked into gear in late September. The Russell had a decent test of the recent lows without violating the bottom, then closed strong, which is a positive signal. In addition, the market has now left twin long “wicks” on the major low testing days, which is a form of a double bottom. It should be noted that these signs are on daily charts, and it will take a more dynamic formation on weekly charts to support any bottoming theory at this stage of things.

Even investors playing for a bottom that don’t watch chart dynamics have their own story to hang a hat on right now. Some of those elements include: (a) signs that frozen credit markets are starting to thaw vis-à-vis the pullback in Libor rates; (b) various valuation tools suggest the market is a bargain; (c) a majority of market pundits believe that the market has either made the lows, or is close to the low, which means downside risk might not be that bad compared to upside gain; (d) governments around the world have poured hundreds of billions into financial systems, which will stabilize the market. And even though economic statistics are truly dreadful right now, investors banking on a bottom being at hand will say that the worst of that news will lag the actual recovery in stocks.

As for those economic statistics, the day started out fairly tame with weekly unemployment claims a little better than feared and the consumer price inflation report also a tad better than forecast. With inflation fears completely out the window, the market is anticipating additional rate cuts by the Federal Reserve to help generate the economic recovery. It should be noted that seeing unemployment claims in a positive light today was still something of a stretch … after all, the four-week moving average for unemployment claims was at a seven-year peak. By all accounts, the jobs picture in the United States is bleak and the worst of the storm (from a data perspective) hasn’t even started.

But without a big surprise on those two morning data releases, the market seemed comfortable to grind higher — a welcome relief after Wednesday’s demoralizing slide. However, when industrial production registered the largest decline in 34 years the market started to get queasy, and then the Philly Fed survey was the lowest in 18 years and the market quickly resumed the slide. Right before midday, the Russell was down more than 3% and appeared to be headed for the worst daily close in more than a year, which would be a harsh blow to any short-term buyers who have already been trying to pick the low-hanging fruit.

But it quickly became apparent that the midday selling lacked fire and the market pushed back higher, before finishing in the upper portion of the range. The power for today’s move actually came outside the financial arena, with the Financial Select Sector SPDR up 2% and the PHLX KBW Banking Index up 2%. Retail shares did well, with the S&P Retail Index up 4% and airlines were a big hit, with the AMEX Airline Index soaring 21%. Drug stocks and restaurant shares also were in favor, recapturing a small slice of recent declines.

Individual small caps of note included Molecular Insight Pharmaceuticals Inc. (Nasdaq:MIPI), which jumped some 35%, essentially recovering a steep loss from the previous two sessions. UAL Corp. (Nasdaq:UAUA) surged about 37% as sinking fuel costs continue to bolster sagging airlines. Within that group, US Airways Group Inc. (NYSE:LCC) was up 30% and Alaska Air Group Inc. (NYSE:ALK) was up 20%. TechTarget Inc. (Nasdaq:TTGT) rallied about 34%, closing above the 20-day moving average for the first time since late September. Horizon Lines Inc. (NYSE:HRZ) jumped about 28% while Coleman Cable Inc. (Nasdaq:CCIX) rose 30% on earnings news.