By Greg Peel

The Dow closed up 120 points or 1.2% while the S&P gained 0.9% to 1070 and the Nasdaq struggled up 0.7%.

After the big surge on Wednesday night, Wall Street opened higher once again backed by news last week's new jobless claims fell by 21,000 instead of the 12,000 expected. These numbers are highly volatile and the smart money largely ignores them, but any dream will do in a market which is once again toying with risk.

It was not all plain sailing, with an initial 90 point rally in the Dow giving way by midday to be only 30 points up, then a rally, then back again, and then finally a kick to the close. Given the disparity of movement among the three major indices, it is clear the buyers were seeking big blue chip names over smaller stocks. Volume was not anaemic but at 1.1bn on the NYSE was nowhere near “heavy”, and short-covering will still have been very much a part of the push.

As has been the case in Australia, US chain stores have spent the month of June heavily discounting their wares in the face of a wobbling economic recovery. Last night the majors released their same-store sales figures for the month, which collectively rose 3.1% against 3.2% expectation. Results were mixed among the group, but June did mark eleven straight months of increases. Wall Street was nevertheless slightly unnerved by a lack of fresh guidance from retailers ahead of result season.

The need to discount was probably supported by last night's consumer credit numbers for May, which showed a seasonally adjusted decline of 4.5%. The amount of consumer credit outstanding dropped by US$9bn in the month to US$2.4 trillion when economists had expected a fall of only US$2bn. As is often noted, the consumer represents around 75% of the US economy so propensity to spend is all important for the recovery. Once again the wobbles are being exhibited.

But the question is as to whether the slowing in the US recovery has been already sufficiently taken account of in stock prices. Is this sudden rally just a breather in the bear market, or as the Americans would say, just a “head fake”, or had the market already overly discounted a drop back in GDP growth? It's hard to believe, but Wall Street has now been up three days in a row and that hasn't happened since April.

Adding impetus to the turnaround has been a slowly growing feeling in Europe that it, too, overdid the fear. All talk at present is on the ECB's “stress testing” of 91 European banks, the results of which will be published on July 23. Early expectation is that the majority of banks will sufficiently pass analysis of sensitivity to levels of eurozone economic slowdown or recession and that only a handful will be forced to recapitalise.

ECB president Jean-Claude Trichet reinforced such a notion at his monthly press conference last night which follows the release of the central bank's policy statement. The bank left its cash rate at 1% as expected, and pointed out it is continuing to offer unlimited liquidity to the market. While interbank lending rates have risen in Europe, demand for ECB loans has been less than feared. And the bank is now easing back its emergency buying of sovereign bonds – its initial reaction at the peak of the European crisis.

Trichet was nevertheless largely guarded about just how tough the stress tests would be. In theory the ECB should set the sensitivity criteria first and then test each balance sheet accordingly, but sceptics are suggesting the bank will look at balance sheets first and then create a test that most banks will pass.

The Bank of England also kept its cash rate on hold at 0.5% last night as expected. The bank signaled no intention at this stage to recommence quantitative easing.

The euro rallied back another half a percent last night to US$1.27, making its brief drop below US$1.20 last month seem but a distant memory. The US dollar nevertheless rallied against other currencies, meaning the index fell only slightly to 83.74. But while a recovering euro is indicative of fear subsiding, it's the Aussie which has become the risk trader's plaything.

Australian economic data and comments from the RBA are now being watched and analysed offshore like never before. Quite simply, Australia is the low sovereign risk proxy for investment in emerging markets, and China in particular. The face of that risk appetite is the Aussie dollar, which having stared at US$0.80 when the euro hit US$1.20 is now back at US$0.8770 after another 1.3 cent rally over 24 hours. Australia's employment numbers released yesterday were all the talk of Wall Street.

With the S&P 500 having reconquered its 1040 breakdown level and then the Dow having reconquered 10,000, the next signal required by the bulls was a return to a US ten-year bond yield above 3%. It's only a psychological round number level, but when the tens opened above 3% last night and held to a 5 basis point increase to 3.04% another stock market rally was on the cards. Rising yields imply investors are taking money out of the safe haven of Treasuries and putting it back into risk assets.

Gold continues to bumble back and forward around the US$1200 mark at present – another round number. Gold should naturally fall as fear abates and a rising euro has sparked selling on that side of the Atlantic. But the US dollar has now also fallen around 5% from its highs which is supportive of gold in USD terms. Last night gold fell US$4.70 to US$1198.50/oz.

It must be noted that this time of the year is typically a period in which gold falls back, given we're in what I call the “dark side of the moon” period between Asian gift giving festivals and subsequent jewellery demand. If risk appetite does continue to return and this rally is not just a head fake, then gold could be set for a more substantial pullback before reestablishing a base.

Oil joined the recovery from pessimism last night in rising US$1.37 to US$75.44/bbl but base metals in London were more wary and closed mixed on small movements. The metals market has now entered the quieter summer season.

It's also worth noting that having risen as high as 40 recently from its low of 15 in April, the VIX volatility index on the S&P 500 has now fallen back to 25 after a couple of sharp moves down. If it falls below 20 in a hurry on an ongoing rally, that rally has gone too far.

The SPI Overnight was up 28 points or 0.6%.

It is interesting to note that both the first quarter 2010 and fourth quarter 2009 results seasons in the US were dominated by scares in Europe – firstly Greece and then wider contagion fears – such that actual results were a bit lost in the wash. The second quarter result season starts on Monday, and this time we are coming out of a fear period (hopefully) rather than going into one. If this is more than just a head fake rally, it will all come down to US earnings results over the next few weeks.

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