Another Bear Market Rally or a Time to Buy Stocks?

The stock market is looking a little stronger and investors are dipping back into equities following a three month decline

. In the US, the Dow Jones is closing above the 10,000 level once again and the in the UK, the FTSE 100 is firmly back above the 5,000 mark. These big-figure-levels look lo be offering price support and are helping to attract buyers.

The real test starts now for the markets. The question is whether they can sustain these gains?

At the moment there is a concern for the bulls. Looking at the spread trading charts, the lower-lows and lower-highs of the FTSE 100 indicate that the overall down trend is set to continue. Note though that there is certainly some pressure to the upside for the FTSE 100 as the recent gains have taken us back above the 20-day and 50-day moving averages where resistance can normally be expected.

The theme for now is the European banking stress tests. For all of the criticism that they are getting the markets still remember the US stress tests that were undertaken nearly a year-and-a-half ago. The US tests were thorough enough to allay many traders' concerns that the US banks would at least be able to withstand another shock to the system.

This time around it is the turn of some 90 or so European banks to go through some similar tests to see if they can survive another recession or shock, should it materialize. The new stress tests will also cover how such a shock could affect other banks and, ultimately, what would happen to the flow of credit a key part of the test. If the credit markets were to freeze like they did in 2007, then we could be in a serious pickle for the rest of 2010 and 2011.

Of course there are a few differences between now and the shocks of three years ago. As Simon Denham of Capital Spreads commented, "Today the banks are required to hold more capital. Not only that but some of the largest big banks are propped up by the various governments. It is hard to see the tests revealing much more than what we would all want them to reveal".

So if the banks are given a clean bill of health then stocks may continue to climb. Not only this but with inflation remaining under control and governments planning to implement a range of stringent austerity measures it is difficult to see interest rate rises for some time yet. Raising the cost of capital now, ahead of big spending cuts, would be a rather poor decision. The ongoing low rates therefore make the returns on trading shares and bonds far more attractive.

So can the stock markets sustain these gains? Are we in another bear market rally or not? For me the problem is still the lower-lows and lower-highs of the FTSE. Whilst I don't want to miss the next uptrend I might just keep any new trade sizes smaller than usual.

Another Bear Market Rally or a Time to Buy Stocks?

By: Thomas Bainbridge

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