Last week was undoubtedly a great week for stocks. Even with one less trading day, the Dow climbed 5.28%, the S&P 500 gained 5.41% and the Nasdaq added 5%. There was not a single down day and the fear indicators retreated.

This is all very bullish and I have been making my short-term predictions for this bounce as well. Some notorious bears like Doug Kass say that the bottom has been put in for the year and the media has been talkng about stocks testing the lows (so you know it won’t happen).

Then why am I not convinced that this rally will last beyond an oversold bounce? This is not to say that I am bearish, my recent articles say the opposite, but I am simply not willing to jump in with both feet just yet. 

What troubles me the most is the fact that there does not seem to be any institutional buying which is the only way we can continue this rally. Volume has been very light, which has been the case for the past 14 months, but I mean really light.

I’ve read some recent articles on Hedge Fund performance in June, which was one of the worst months since 2008, which leads me to believe that the “window dressing” that was expected at the end of June was actually replace with liquidation due to fund redemptions. In other words, instead of seeing institutional buying at the end of the month/quarter to boost their numbers, funds had to sell some of their holdings beacause their clients were pulling their money out.

This was demonstrated in spades when Gold took a big hit at the beginning of July as hedge fund manager John Paulson, the biggest holder of the SPDR Gold Trust ETF (NYSE:GLD), had to liquidate some of his holdings to cover the over $2 billion in client redemptions.

In addition to this, I’ve read several other articles on the cash levels being held by institutions and their reluctance to pile into equities. Sort of a “deer in the headlights” situation.

Of course, I am always skeptical of what I read in the news, but these articles have been useful to help me confirm my thesis of what has been going on in the institutional investing world.

Timing is also a big factor. We are about to kick-off earnings season with Alcoa (NYSE:AA), the first Dow 30 component to reporting earnings after the close on Monday. There will surely be volume coming in this week and the results will likely determine direction of the markets for the next few months.

Needless to say, positive results and strong forecasts will give hedge funds the conviction they need to begin accumulating again. I do not like to make predictions on earnings as I do not have a team of specialized analysts at my disposal. Not to mention the fact that I’ve seen many positive earnings results be met with sell offs. The devil is in the details and earnings headlines seldom give a clear picture of what the full report will reveal.

My general expectations for this round of earnings is results that are not as strong as the first quarter. The markets did crash after the last batch of earnings was released, caused largely by sovereign debt problems, but forecasts for the rest of the year were below the expectations of many.

Since stocks have shed some valuation multiples over the past couple of months, and some analyst estimates have been reduced, the markets could be more forgiving of mediocre second quarter results so long as the earnings guidance is good enough for the street.

While there are some leading indicators that I have been monitoring that signal a continued reversal to the upside, the market does not move purely on technicals. The markets need to react well to earnings in order for the current rally to continue. If this is the case, the bottom could very well be in for the year, if not expect a triple digit level on the S&P 500.

Not to toot my own horn, but I pretty much nailed the rally by going long on Friday and writing this post.

Written By Jordi Perez From Market Space Trading

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