Stock Market Today: Buying the Rumors

On July 15th, after six consecutive down days, during which time investors had been treated to any number of negative headlines on the state of the U.S. economy, the weakening outlook in China (FXI), the latest Li(e)bor scandal, as well as the never-ending debt crisis facing Eurozone (EZU), the market had spiked higher - on a Friday the 13th no less.

If you recall, this particular joyride to the upside in the stock market (SPY, DIA, QQQ, IWM, MDY) was triggered by comments from Atlanta Fed President Dennis Lockhart, who told an audience that "another policy decision looms" and that the FOMC could indeed take further action before the current round of Operation Twist ends.

Boom. Risk on, baby. The algos knew exactly what to do with that headline.

Since then, traders have largely been "buying the rumor" that the Bernanke cavalry will mount their white horses and ride to the rescue of the U.S. economy (which has seen GDP growth falter from a 4% rate to just 1.5% in six month's time).

But to be fair, we do need to recognize that in between rallies stocks succumbed to another four-day rout in reaction to the latest flare-up in Europe, which saw bond yields in Spain (EWP) and Italy (EWI) shoot to new Euro-era highs.

But, with yields, CDs, and bond spreads in Spain moving above the 7% mark, which is widely considered to be the point of no return, investors were soon treated to another reason to "buy the rumor." In short, while hopes for more QE in the U.S. is worthy of a decent "risk on" rally, if the ECB were to suddenly get off their duff and take action about the crisis in Europe, well, there just might be something more than a rumor to buy.

Perhaps Mario Draghi will disappoint on Thursday and the ECB won't cut rates again or start buying bonds. Maybe the Fed won't do anything at their Tuesday/Wednesday meeting or even hint at more stimulus. However, two things have led traders to believe that there is actually something beyond hope happening here.

First, there is the fact that WSJ reporter and purported Fed mouthpiece Jon Hilsenrath has recently laid out the options Bernanke's gang could take in either August or September. And since (a) the U.S. economic data has been sucking wind for a while now and (b) Ben Bernanke is keen on communication via the markets, it would seem that the Fed is indeed on the verge of taking additional action.

On that note, the same can be said for the ECB. While Super Mario has indeed accidentally misled markets with statements in the past, he also quickly said as much soon after. However this time around, there have been no statements from Draghi or ECB spokesmen suggesting that Draghi had been misunderstood. And with reports on Friday indicating that Draghi will be meeting with German Fin Min Schäuble prior to Thursday's ECB meeting to discuss the central bank's options, the markets do seem to be justified in getting their hopes up.

To be sure, if either of the world's superheroes of finance disappoints this week, stocks will suffer - and quickly. However, so far at least, there doesn't seem to be any real reason to think that Draghi or Bernanke has been deliberately misleading the markets. No, just the opposite appears to be true. Remember, the comments from Draghi last week were out of the ordinary for a central banker and appeared to be quite clear in their meaning. Recall that Draghi told an audience, "Believe me, it will be enough" in reference to the ECB's upcoming policy response.

In "Fedspeak" this type of comment was intended to be a threat to those continuing to short Spanish and Italian bonds. Put simply, Draghi appeared to be warning that anyone betting on higher rates in Spain might be in for a great deal of pain should they continue to do so. Apparently bond traders received the message loud and clear as the yield on the Spanish 10-year bond plunged from a Euro-era record of 7.62% on July 23rd to 6.76% at Friday's close.

So, is "the bazooka" on its way? Will the EU Central Bank AND the U.S. Fed take aggressive action in the same week? In reality, only time will tell. But from where I sit, the game right now is all about buying the rumor.

Positions in stocks mentioned: SPY

Follow Mr. Moenning on Twitter: @StateDave (Twitter is the new ticker tape)

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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