Given the stock market’s remarkable surge the last couple of days, anyone reading only the headlines might get the impression that all our economic troubles were behind us – the mortgage crisis, falling home prices, dark clouds of recession, the sickly dollar, etcetera.  Alas, all of those problems are still very much with us and growing, even if Wall Street’s wildly exuberant behavior would seem to suggest strongly otherwise.  But what’s a headline writer supposed to do?  Probably no parabolic stock-market rally in history has ever been properly described as having resulted from a massive short-squeeze. And yet, that is precisely what caused shares to explode yesterday against the most depressing economic backdrop since Americans queued for blocks to buy gasoline in the early 1970s.

(Click on chart to enlarge)

What triggered the buying panic was a dovish speech by the Fed’s vice-chairman, who acknowledged that the credit markets have deteriorated dramatically since the last round of easing.  Now, we doubt there is anyone on earth who is so stupid as to believe that another rate cut, even a big one, is going to transform a rapidly deflating $13 trillion economy into a booming one – and, make no mistake, it will take no less than the rekindling of a full-blown housing boom to merely nudge consumer spending up to levels that would allow us, yet one more time, to dodge the bullet of recession-or-worse.

Why the Frenzy?

So if no one actually believes easing will accomplish much – other than, perhaps, to accelerate the dollar’s destruction – then why were buyers whipped into a frenzy yesterday on the NYSE?  The answer is that they were buying simply because they recognized that none of their OPM-churning colleagues would be able to suppress the buying reflex in the face of a dovish speech from the Fed.

We have no doubt that those who paid up for shares yesterday will eventually come to regret it. Even so, we can only defer for the time being to the irresistible power of this short-squeeze, which we expect to continue at least into today. For we are likely to find that demand arising purely from short-covering will not have abated much, since bears never had a chance to escape from the ringer yesterday.  Indeed, the Dow Industrials gapped sharply higher on the opening bar, then scarcely corrected for the next six hours. This has consequences for Thursday morning that are potentially tradable and which have been analyzed in detail in the touts section of Thursday’s Rick’s Picks. To anyone who would rather experience Thursday’s opening hour as a disinterested observer rather than as a victim, I would urge you to check it out.