Last night's ferocious rally in US equity markets has spread through the Australasian region today, providing relief for nervous investors.
The markets are putting on a daily Jekyll and Hyde show…one day, the US housing market looks like bringing the world economy down with it, and the next, popular opinion says the worst is behind us.
The best way to make any sense of all this confusion is to take day to day stock market movements with a very large grain of salt, and concentrate on the longer term trends.
Last night's spectacular rally in the US for example provided some interesting justifications.
We were told the rally was the result of Federal Reserve Governor Donald Kohn suggesting further interest rates cuts would be necessary to help revive a struggling economy;
"Heightened concerns about larger losses at financial institutions now reflected in various markets have depressed equity prices and could induce more intermediaries to adopt a more defensive posture in granting credit, not only for house purchases, but for other uses a well."
Rather than supervise the markets removing their own punch form the punchbowl, the Fed is preparing to keep the party going by providing more credit to the system.
But why would this realisation lead to one of the biggest one day rallies in years.
After all, prior to Kohn's speech, investors had already placed a 90% plus probability on a cut in the Fed funds rate in December, with expectations of a further cut early next year.
Perhaps the Fed will deliver a 50 basis points rate reduction when they meet in December 11.
More than likely, last night's rally was the result of short covering, whereby traders who have previously bet on falling share prices look to ‘cover their shorts' buy buying back their short positions.
The financial sector was the biggest beneficiary, and a sharp rally here should not be surprising considering the magnitude of recent falls.
However, if you focus on the wood and not the trees, you'll see that the trend looks noticeably dire for the majority of US financial stocks.
We're not out of the err…woods just yet, and that means more daily volatility for Australasian markets.
