What are the odds for an oversold bounce this week?

06/04/2012 1:06 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

As the week begins, I expect traders who have made big profits on the May decline to be weighing the risk/reward of letting their bets on further declines ride versus taking profits now. Their decision will determine whether an oversold market gets more oversold or whether we get an explosive bounce.

Stocks turned in their worst May performance this year since 1940 with the Standard & Poor’s 500 stock index falling 6.01% for the month. And that was before the plunge on June 1 that sent the S&P 500 down 2.5% for the day. (The Dow Jones Industrial Average fell 2.2% on Friday and the NASDAQ Composite Index dropped by 2.8%.)

That has moved U.S. stocks to a very oversold condition. The Chartist’s http://www.thechartist.com/ Dan Sullivan, for example, calculates that the market has only been this oversold once since last November.

But as the saying goes, an oversold market can get more oversold so the Friday reading by itself doesn’t mean we’re looking an a bounce in the near future.

I think the timing of any bounce, indeed the likelihood of any bounce, depends on how those who have sold financial assets short calculate event risk in the coming weeks.

We’ve certainly got a lot of potentially market moving events coming up:

The European Central Bank meets on June 6. It could cut its current 1% benchmark interest rate (but probably won’t), announce a renewed policy of buying Spanish and/or Italian government debt (probably not), or offer banks another round of cheap 3-year loans (almost certainly not.) The odds are that the bank won’t do anything in order to keep pressure on European political leaders to do something—but, hey, you never know.

OPEC (the Organization of Petroleum Exporting Countries) meets in Vienna on June 14. Iran and Saudi Arabia are expected to clash over Saudi Arabia’s increases in oil production and the proper target price for oil. The Saudi’s have said they think $100 a barrel (for the Brent benchmark) is an appropriate level, but market’s expect them to overshoot to the downside with prices, perhaps, dropping as low as $90 a barrel. Lower oil prices provide a boost to global economic growth. Brent crude closed at $98.81 on Friday.

Greek voters go to the polls on June 17 in an election that might decide whether Greek sticks with the euro or not. The final polls before the election have been so volatile that it’s impossible to tell what parties are ahead or might be gaining momentum.

The Federal Reserve’s Open Markets Committee meets on June 19-20 with a policy statement due on June 20. The Fed could announce a new round of quantitative easing that extended its Operation Twist program of selling short-term Treasuries and buying long-term Treasuries or it could even decide to buy Treasuries and increase the size of its balance sheet. I don’t think the Fed has laid its typical groundwork for either of these moves but with the U.S. Presidential election looming in November, the Fed might feel it needs to act sooner rather than later.

And finally the end of the month, June 28-29, brings the next summit of European leaders with proposals for a Europe wide deposit guarantee, Eurobonds, a growth pact, and changes to the European bailout fund that would allow the fund to directly recapitalize banks all on the agenda.

I think the odds that any of these events will deliver anything that is a real solution to the crisis are pretty small. But we could see something that seems an improvement over the almost total gloom and doom of June 1.

If you were sitting on profits from being short in May, would you decide risk them on the results of all these events or would you buy to cover and step out of the market for a few weeks?

The answer to that will determine if and when we see that oversold bounce.

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