A Swine Flu Stress Test For The Markets

I have written before that we are likely experiencing a bear market rally in equities. We have seen signs of capitulation by bears and short-sellers. William Hester of Hussman Funds concurred with this view, see his incisive analysis of volume behavior in previous rallies. Mark Hulbert is more agnostic on the rally vs. renewed bull controversy, but indicated that we will likely see a re-test of the March lows.

All this debate is well and good, but why did the market continue to rise? And what is the market going to do now?

The acid test

As I write this fair value on S&P 500 futures is down just under 2% as news broke that the World Health Organization declared an outbreak of a previously unknown swine flu virus “a public health emergency of international concern.” WHO Director-General Margaret Chan indicated the outbreak has “pandemic potential.” (For possible market effects of this illness, here are some sample bullish and bearish views).

This equity rally has been characterized by leadership by Financials and low-quality, beaten up stocks, or a manifestation of the Phoenix effect. If this news panics the markets in the days to come, watch how the leadership behaves to gauge the resiliency of the rally.

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