The stock market

Is the Market Rally Just a Set-Up for a Bigger 'Collapse'?

Global stocks have been rallying in recent weeks, climbing a “wall of worry” and confounding the bears, leading a number of strategists to warn the gains are unlikely to last and investors should remain cautious.

CNBC,

8 August, 2012

“I think we’re in choppy waters and that continues. You’ve got to remember to sell if you own the stock market now,” Charlie Morris, Head of Absolute Return at HSBC Global Asset Management told CNBC Europe’s “Squawk Box” on Wednesday.

Morris says with bad news on the global economy over the past year, the market had “tried to collapse”, but with so many people short stocks, the conditions hadn’t been ripe. That, he says, could change after the current rally ends.

“You need to trip the market to have a proper collapse. So you almost need to set it up with a rally, get everyone excited and then it can fall,” Morris said. “If there are risks, the risks to a very negative market come after this rally fades.”

U.S. stocks gained for a third consecutive session on Tuesday with the S&P 500 finishing above 1400, while European stocks hit a 4-month high on expectations policymakers will soon decisively address the region’s debt crisis. Asian stocks also hit a three-month high on Wednesday, with Japan’s Nikkei breaking above its 75-day moving average.

Sandy Jadeja, Chief Technical Analyst at City Index told CNBC on Tuesday that despite being bullish on the Dow for the past two weeks he was now growing concerned. He said there was a clear divergence between the technical indicators and the current price levels on longer-term charts for the Dow.

“Watch out for the end of this week, if we start seeing a negative close by the end of the week, that would suggest that next week, and the week after, we’ll start pushing to the lower side.”

Other market watchers have been warning that based on economic fundamentals, the current rally is irrational. "The rally on Friday after the release of the employment figures and the consumer confidence index really has no economic merit," Dan Geller, chief research officer of the Money Market Index economic index told CNBC Monday. (Related: Jittery Market Basics)

Barclays equity strategist Barry Knapp also pointed out in a note to clients on Wednesday that the underlying factors in terms of “expectations of U.S. and global growth deterioration, less accommodative monetary policy, earnings growth deceleration and elevated public policy uncertainty” were the same as they had been in the second quarter when U.S. stocks dropped 10 percent.

He said investors who were defensively positioned could buy call options on small cap stocks and select cyclical stocks to ensure they didn’t lose out on the rally. But, he added: “We remain unconvinced that investors should chase the low volume 'wall of worry' August rally.”