November 21, 2012
Santa Claus is Comin’ to Town
Just over two weeks ago, President Obama was reelected and the markets booed (whined?) by immediately nose-diving, selling off hundreds of points.
While it is largely true that President Obama’s policies are negative for the economy, the stock market and economy, very often, do not march in lockstep. There is a long history of the market doing well while the economy does poorly and visa versa, so it is important to separate macro economic views from near-term stock market expectations.
It is a bit like driving a beat up old clunker with a fancy set of new wheels, but if we can look away from (read: ignore) the train wreck of macro economic problems, we can feel good about the high probability of the pending stock market Santa Clause rally.
The evidence pointing to the likelihood of a market rally is substantial and even suggests what more erudite market observers might refer to as a “rip your face off rally”.
Here’s is the evidence:
The NYMO (New York Stock Exchange McClellan Oscillator) is the most consistent and most reliable technical indicator for predicting market moves, that we are aware of. This past Friday, it was stretched to oversold extremes. On Monday, the market bounced violently.
The AAII (American Association of Individual Investors) surveys their members weekly to measure bullish verses bearish sentiment. Last week's survey showed extreme bearishness. The AAII survey is a contrary indicator because it has an impeccable record of being almost perfectly wrong.
Another great, highly reliable contrary indicator is the ratio of put options verses call options being issued. As of this week, the ratio had climbed to over one. Fear drives investors to buy puts and fear is greatest near a market bottom. When more puts are being sold than calls (showing more pessimism than optimism), this generally indicates we are at or near a market bottom.
QE3 (Quantitative Easing round three) has so far been the Rodney Dangerfield of Quantitative Easing. Despite the lack of respect for QE3, it is still out there dumping $40,000,000,000.00 of newly minted dollars into the market each month. Again, one can question the long-term wisdom and morality of borrowing money from our grandchildren (that we never intend to repay), but short-term, the market always loves a sugar high!
Above, we mentioned Monday’s bounce after the NYMO was stretched to oversold extremes - Monday’s bounce was not your ordinary garden-variety bounce - it was much more! When you dig beneath the surface of Monday’s market bounce, you can see broad based buying where buyers overwhelmed sellers, gobbling up shares by buying at the “ask” rather than the “bid”. Decoded, this means that those who were buying shares were willing to pay the price being asked by the would be sellers rather than the sellers accepting the price being offered by the potential buyers. When demand exceeds supply, sellers are in the driver's seat and shares tend to be bought at the price being asked. When supply exceeds demand shares trade hands at the price being bid.
Monday’s internal price action tells the story of big institutional buyers willing to buy stock shares at the prices being asked. On Monday, the up volume verses down volume was one of the highest recorded this year. This broad based buying, where everything is being bought happens when huge institutional buyers are throwing money at the market. It almost always means stock prices are headed higher over the near term.
Think of an elephant stepping into a swimming pool; it can’t help but cause the water level to rise. When the elephants (big institutional buyers) pile into the pool (the market) the water level (stock prices) rise.
Keep in mind that markets do not go straight up or straight down. After the big one-day gain on Monday, the market needs to digest those gains or even pullback some before it can move significantly higher. It is normal for the market to even pull all the way back to “retest” the low point just established. So be patient, it could take a few trading sessions before the Santa Claus rally gets underway and once it does, it will not go straight up.
By our estimation, odds are that we will see a Santa Claus rally come early this year. So this Thanksgiving, sometime between football games and binging on Aunt Mildred’s signature tofu stuffing, you might want to hang your stocking from the mantle. It can’t hurt to give Santa a drop off spot.
On a more serious note, while we are fortunate to enjoy this Thanksgiving Day with our families, Israel is under attack. I hope we all keep the Israeli people, their leaders and soldiers in our thoughts and prayers.