Seeking Alpha
Long/short equity, deep value, registered investment advisor, CFA
Profile| Send Message|
( followers)  

Last Thursday, I noted on Seeking Alpha ("The Stock Market Rebound Is Coming") that although the market faced a struggle through the rest of the week, there was a good case for a market rally into the end of the year. The S&P 500 fell to 1343 and change Friday morning, just shy of my putative 1340 support line, and has since rebounded about three percent. The point of this week's essay, which I am writing a day earlier than usual in deference to the Thanksgiving holiday, is to examine to what degree the case is still intact. It is too early for victory laps.

Last week generated strong reactions and a considerable amount of commentary. My opinion was written as a short-term market call through the end of the year, so I will not directly address any of the long-term structural objections that some readers raised. There are valid long-term issues about the economy, but it's important to remember that historically this is not a time of the year for the market to start having deep thoughts about them.

Let's take up again where I led off last week, with the technical and trading action. Short term, the S&P has gone from strongly oversold to only mildly so after the big Friday-Monday reversal. On an intermediate basis, the index was as oversold last week as it was last May and - oddly enough - a year ago November. Both prior periods were followed by the typical compression rebounds one gets in the absence of a crash. For those who follow such things, the MACD indicator also looks like it's about to turn constructive.

The trading action in Apple (AAPL) over the last several days was remarkable. The stock was trading above $540 at Wednesday lunchtime, and then printed down to $505 by the European close at 11:30 Friday morning. From there until Monday's close, it rose by 60 points, or nearly 12%. Two things stand out to me about this. Number one is options action: Friday was the November options expiration, and it looked to me like traders started covering as soon as the bell rang that afternoon. I have seen this movie before.

Two, the negative trading momentum in Apple and the broad indices now seems to be over. There are probably more Seeking Alpha articles on Apple than any other stock, and I have no wish to get in the middle of the valuation battle, but it's easy to see on the Apple chart that the short-term momentum has been broken for now. At this point I would not be surprised to see Apple drift back towards 600, which would help the tape.

I wouldn't expect the market to go up in a straight line. However, I can easily see the S&P reaching 1425 again by year-end based on just a handful of days. Favorable stories about Greece, more Fed securities buying, positive Apple sales (which were all gloomy for several weeks) and above all a budget cliff fall avoided could combine with HFT trading to get us there. It's only about three percent away.

For those still upset about Monday's rally, they should remember that a little news goes a long way in an extreme market - especially on post-expiration Mondays. The big rebound drew reproaches from many, including some of the usual cast of characters, such as Peter Schiff, who has been predicting Armageddon for as long as I can remember, and David Kostin, the Goldman strategist. David opined that the S&P could reach 1250 in December, based on uncertainty over the fiscal cliff, the debt ceiling, and the desire to pay capital gains taxes this year. In mid-March, David also opined that the S&P would reach 1250, but based on a stagnant economy, weak earnings growth, and no multiple expansion.

To his credit, the S&P is no higher now than it was then, and it came close to that level in June. However, the S&P 500 hasn't fallen more than 6% in a December since at least 1950 (as far as my own data goes back), and the one time it touched that level was in 2002, a year when the market was off by more than 20% during a recession. Weak Decembers during positive return years for the market can happen, but they are uncommon. Traders no longer seem morose. For a contrary opinion to Kostin, here's another persuasive Bloomberg clip arguing that stocks are not expensive. It reflects what some managers are thinking.

The housing news this week was constructive. Housing starts in September and October (using unadjusted data) were the first two months since the crash to surpass pre-crash levels. It's true that housing was already going downhill fast in 2008, and the level of starts is still weak compared to 1990-1992 recession levels. It is progress, though. and housing looks set to continue as a mild, but growing contributor. The starts data certainly aren't going to hurt GDP and employment this quarter.

The industrial data last week had some positives better than I expected, despite the weak headline results. New orders in the New York region swung positive, and if the Fed is to be believed about its estimate of a near-1% impact by Sandy on industrial production, we could see positive recovery action spread out over the next few months. Employment data will be lumpy in the near term, but will also benefit from having Sandy as an excuse.

Evidently there are risks, beginning with the budget process. If it fails spectacularly, all bets are off. There are articles and opinions flying about whether some sort of deal is possible or not, including this one by Ben White this morning on the Politico website that reported some Republican willingness to make a deal and move on. Certainly one can find hard core types in both camps who are ready for martyrdom, but I believe that the leadership on both sides very much wants to avoid an explosion. It's hard to lead when you're a martyr.

To those who worry about whether the budget process will be a one-step or two-step deal, whether it will be efficacious or whether any deal at all can do good, I would say that while they may be valid questions, the market doesn't want to focus on them until it has to. Look at the history of the EU over the last three years, and you should understand that any half-decent extension and announcement of intentions to get it right eventually will suffice to push prices higher in the short term. The big dance over long-term finances is more likely to be next year.

The EU and the Middle East are still potential problems, but here the calendar is also favorable. I believe that the EU will have its crisis moment in time, but it won't come between now and the end of the year. In Israel and Palestine, ceasefires are easier to arrange in December when it's cool and rainy. Obviously wars can and do happen at any time, but people are less apt to start them in difficult weather. I cannot remember a time when the Middle East wasn't at risk of having a conflict break out.

Two big tape negatives are now in the rear-view mirror. The first was the election, which seemed to catch Wall Street by surprise, and that itself was a surprise. The result seemed to flip the Street from a Romney-win, budget-risk-off perspective to an Obama-won, budget-risk-on perspective. Now that we have passed through the second negative of November options expiration and heard soothing words about the budget, the market is poised to rally further.

If the fiscal impasse develops instead, prices will of course suffer, but the market is now in a place where it wants to believe. Don't overlook the exaggerated impact of a positive concrete development on the budget, even if it takes until mid- to late December. Bernanke's optimism today about the consequences of a good deal might have been in the call of professional duty, but the markets will be happy to remember it in the midst of a budget rally.

Very few managers are in a position to play defense through the end of the year. If a budget deal starts to look likely - albeit only a fix-it that postpones many of the larger issues - money could come racing back in as the performance derby suddenly gets deadly serious. That's set up to matter next month more than any philosophical debates about the size of government, the best way to strengthen the EU, or the role of the Fed. The stock market will be quite happy to put off worrying about such problems until next year.

Source: The Case For The Rebound Is Still Intact

Additional disclosure: I am long Apple calls.