Once again, the stock market's favorable season is producing an impressive rally. The Dow has gained more than 10% since its November low, with the rally accelerating in the new year -- a 7% gain in just the last 4 weeks.
There are certainly reasons for optimism and the market rally.
As it has for the last three years, the economic recovery has resumed impressively after its summer stumble. Most U.S. economic reports, in housing, employment, retail sales, manufacturing, are beating even optimistic forecasts. The eurozone debt crisis has moved out of the headlines, ECB president Draghi's promise of "whatever it takes" having successfully kicked the crisis down the road. In Asia, fears that China's economy was slowing into a hard landing have been alleviated by several months of much better than expected economic reports.
The political uncertainty of the U.S. Presidential election, and the unusually divisive election campaign, is now history. The more recent concerns, that an agreement to extend the Bush-era tax cuts would not be reached by year-end, and that the debt ceiling would not be raised in time to prevent the government from shutting down by mid-February, have been kicked down the road by several months.
What is it about winter months?
It never ceases to amaze me how background conditions work out to continue the long history of the market making most of its gains each year in the winter months (and when there is a correction of any degree, it almost always takes place in the unfavorable season between May and November).
It's not just a phenomenon of the U.S. market. Academic studies show similar seasonality in the markets of 36 of 37 developed countries.
The favorable season traditionally lasts until May, and Congress has pushed the debt ceiling deadline out to mid-May to give both sides more time to hammer out a budget agreement.
So there are reasons to expect the favorable season rally to continue, and I and my subscribers remain 100% invested in our Seasonal Timing Strategy portfolio, and 80% invested in our non-seasonal Market-Timing Strategy, enjoying the ride and expecting more gains ahead.
There is certainly a tremendous amount of cash on the sidelines earning next to nothing in savings accounts and bond funds to fuel a further rally. And there is evidence that previously bearish and pessimistic investors who took money out of the stock market in 2009, 2010, 2011, and right up until mid-year last year, long after the new bull market began in early 2009, are now pouring money back in.
Fund-tracker Lipper Inc. reports that over the last two weeks, U.S. stock mutual funds experienced the highest two-week inflow of new money since April, 2000. And the Investment Company Institute reports that deposits into mutual funds last week were the highest since early 2007.
But most investors are terrible market-timers, especially those who think of themselves as buy and hold investors, and for now, I'm going to ignore the fact that April 2000 was just about the peak of the 1991-2000 bull market, and early 2007 was only months before the 2003-2007 bull market ended. I'll ignore it because this time, the inflow has just begun, while in 2000 and 2007, although beginning late in those bull markets, the inflow had lasted for a couple of years.
The change in sentiment is also showing up in this week's poll of its members by the American Association of Individual Investors, which showed sentiment jumped to 52.3% bullish, and bearishness dropped to only 24.3%.
However, investors should not become too exuberant, too willing to buy and hold, too confident that all is well again for the long term.
The uncompromising antagonism in Washington that upsets markets will soon rise again, as budget and debt ceiling talks resume leading up to the next deadline, now pushed out to April or May.
And by summer, it's liable to be a gloomy "big-picture" scenario again, brought on by the slowing effect on the economy of government spending cuts to bring budget deficits under control, or the Fed beginning to remove the stimulus punch bowl, a return of the eurozone crisis, or of inflation finally beginning to show up.
So enjoy the rally, but study up on how markets really work. Think cycles, not endless trends. And keep in mind that even in sustained rallies, the market doesn't move in a straight line. The market has been up 11 of the last 12 days. That has investor optimism rising and money flowing in to an unusual degree. But it also has the market short-term overbought and so vulnerable to at least a short-term pullback.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.