Short Covering, or the Beginning of Something Special?
by Charles B. Carlson, CFA
Dow Theory Forecasts

The market, not withstanding recent pullbacks, has exploded upward in the last three weeks. The big question, obviously, is - Why?

How you answer that question depends on whether you think this market move has legs.

Certainly short covering has a lot to do with the market's strength in recent trading. To be sure, these short sellers covering their positions are probably not all that bullish. Rather, they are just playing it safe, waiting to see if this market behaves similarly to the beginning of the Gulf War in 1991, when the market exploded higher and never looked back.

Another reason for the strength is that investors, remembering how stocks rallied when the war started in 1991, are buying in anticipation of another similar move.

The problem with these two explanations is that they provide no real reason for this move to have legs much past the next few weeks.

Indeed, the only reason to be long-term bullish right now is that you believe that corporate profits will be heading consistently higher over the next several quarters.

If that happens - and I believe it will - you should be bullish on stocks. If, on the other hand, you don't see corporate profits moving meaningfully higher over the next three quarters, you should be selling into this rally.

Simple as that.

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