Stocks, which seemed poised for an upside breakout a day earlier, took a nose dive Tuesday, raising fears that the 10-week-old rally could turn out to be a head fake.
Dragging down stocks was another record close for crude oil, which jumped $2.02 to $129.07 a barrel. Oil tycoon T. Boone Pickens, in a CNBC interview, predicted crude would hit $150 by the end of the year. A higher-than-expected reading on inflation at the wholesale level in April also hurt. Both trends are unfriendly to consumers, because they mean higher prices for gas and other items.
Ever since the Standard & Poor's 500 index broke above 1400 last week, a ceiling it's been stuck under most of the year, Wall Street has been debating whether the current rally, which has driven prices up 11% since the March 10 low, is for real. Despite a 1% drop Tuesday, the S&P closed at 1413.
Analysts who monitor stock charts say two things must happen to convince them the rally is sustainable. First, stocks must break out above the 1300-to-1400 range the S&P 500 has been trapped in most of 2008 — and stay above 1400 for good. So far, so good. It has closed above that level seven-straight sessions.
Breaking out of a trading range is often a bullish sign. It's not uncommon for investors sitting on the sidelines to jump back into the market when stocks stay above levels that have sparked selling in prior rallies, says Chris Johnson, chief investment strategist at Johnson Research Group.
A second ingredient, and perhaps more important to confirm a market uptrend, is for the S&P 500 to climb above its average price for the past 200 days and stay there, says Bruce Bittles, chief investment strategist at R.W. Baird. That has yet to occur and is cause for concern. Monday, the index briefly surpassed 1428, its current 200-day moving average, but was 15 points below that level after Tuesday's drop.
Earlier this year, the S&P 500 fell nearly 19% from its October all-time high amid fears of recession and a severe credit crunch that has hobbled banks and stressed the financial system. But since bottoming, stocks have rebounded on optimism that the recession may not be as severe as some bearish pundits have predicted, says Dave Campbell, a money manager at Bingham Osborn & Scarborough.
But a fake-out can't be ruled out, says Rich Suttmeier, founder of Global Market Consultants. He says stocks are likely to fall hard if the expected second-half economic recovery fails to materialize. And with inflation on the rise, oil at record highs and consumer sentiment at its lowest since 1980, it's hard to see things getting much better later this year, he says.