Are We Setting Up for a Year-End Rally?

The markets sort of paused yesterday after six straight up days (except for the Dow, up another 0.20%). So what to expect now? If we do get a slight (3%-5%) correction from here to consolidate recent gains, it is important to see if the 1,066 and 1,047 levels hold, which are the 32-day and 65-day moving averages respectively. If these levels hold, then we could see a year-end rally as under-invested portfolio managers catch up with their buying.

Quoting Jeff Saut from Raymond James:

Ladies and gentlemen, to an underinvested portfolio manager the current environment is a nightmare, especially if you believe as we do that we are going to see an upside celebration into year-end. Manifestly, we have argued that with credit spreads below their pre-Lehman bankruptcy levels there should be no reason why the equity markets can’t “fill up” the downside vacuum created in the charts by said bankruptcy. As can be seen in the following chart, that gives the S&P 500 an upside target of 1200 – 1250. If correct, it implies that the cash rich, underinvested portfolio managers (PMs) will once again be forced to chase stocks higher. Our guess is the PMs will chase the “winners” since the March lows rather than buying the laggards. That suggests investments in emerging and frontier markets, technology, financials, base/precious metals, etc. should trade higher if the aforementioned scenario plays.

I don't know if a 1200-1250 target (10%-14% upside) is possible by year-end, given that the indexes are range bound, with the S&P 500 upper end of the range at about 1140-1150. As of now I'd have to assume that the ranges will be intact, but anything's possible.

I can't really see the markets zooming straight up from here without a minor consolidation/correction first, given the slowing MACD momentum and the short-term extended conditions. A break below the 65-day moving average should see the our chances for a year-end rally go up in smokes. But judging by recent market action, it looks like we're going to have one.

In conclusion, I'd suggest refraining from shorting aggressively (I've already been proven wrong shorting this rally and my model portfolio has underperformed as a result of it) despite a possible correction as this will most probably be minor and the persistent V-shaped rallies off of support levels just shows that "dip buyers" are still in control of this market.

Lastly, trying to anticipate anything in this market has proven dangerous (both on the long and short side, but mostly on the short side) so I'm gonna take it one day at a time.

Comments

[Dave Wrixon:]

Jesus, who taught you to use a ruler!

Nov 11 08:29 AM

[The Economi...:]

Terence Chan, not Jesus.

Nov 11 11:04 AM

[bob adamson:]

Thank you, Terence Chan, for raising and discussing this topic. Your rational for continuation of the rally is convincing and might be elaborated upon as follows.

Try to visualize any eight month period in living memory except that since March of this year and ask what the general mood would be if the S&P 500 had increased from 666 at the beginning of that period to 1100 at the end. The general mood would be extremely buoyant and the market consequently overbought. What is going on now, therefore?

Arguably the answer is that the back-story we all focus on now is not the eight month dramatic recovery of stock market prices but rather the traumatic drops preceding March of this year (particularly the plunge of October 2008). This pessimism is simply an expression of an unfocussed anxiety within the population generally in response to the unsettling events of the past couple of years that are unique in their lifetimes. Might not the nature and depth of this pessimism (unique as it is in comparison to earlier states of market sentiment) mean that it and the current recovery in stock prices will last longer?

Arguably, one should be keeping a close eye on day to day developments because the current public mood of unfocussed anxiety can fuel stock market swings in either direction should some future unexpected event (it needn’t be major in its own right) becomes the focus of that anxiety or the apparent basis for it to lift somewhat.

Nov 11 12:15 PM