Stocks Surge, But Will the Rally Last?

07/02/2012 6:45 am EST

Focus: MARKETS

Upward momentum is a rare thing these days, and the recent evidence for further gains after a big pop is decidedly mixed, writes David Berman of The Globe and Mail.

Friday's stock market rally is impressive, but can it last?

The past nine months of market activity have seen the S&P 500 rise 23.5% from its October lows—and within that period, the US benchmark index has posted rallies of 2% or more on nine occasions (not including this latest rally).

We took a look at those nine previous rallies to find out what the S&P 500 did on the next five trading days. Overall, the index fared well—but in most cases, the rally subsided dramatically.

The S&P 500 posted a positive return 78% of the time in the five days following a rally of 2% or more. On average, though, the index rose just 1% over the course of those trading days.

On two occasions, the index was nearly flat, and on two others it fell 1.8% and 3.8%. The best echo rally was the 6.4% gain in early October.

What's interesting is that Friday's rally comes with the S&P 500 beginning the day at its highest starting point for a rally of 2% over this sample period. Can the rally continue with the index at such relative heights?

If you rank the subsequent five-day moves by where the S&P 500 started, you can see an ugly pattern: The higher the S&P 500 is at the start of the one-day rally, the weaker the reaction in the following five days.

For example, the S&P 500 rallied 2.3% on June 6 when the S&P 500 was at 1,315. It then went nowhere for the next five days. The index was also relatively high following rallies on October 27 and November 11...and retreated in the following five trading days on both occasions.

Conversely, the index has seen its biggest follow-through rallies when it has started at lower levels. In early October, it rose 6.4% in the five days following a 2.3% one-day jump—but the index sat at just 1,124 at the time.

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