Patterns Fitting: Stocks Go Higher At The End Of 2013

 |  Includes: DIA, SPY
by: Danny Riley

After being on the floor for the last 35 years and in the S&P futures since 1985, it's hard not to have a forward-looking view of the stock market and where it's going. For the last 22 years I have written a daily piece on the S&P 500. Today I will extend that view to where the stock market will be going into the final quarter of 2013.

As the 2001 recession came to a close, stocks made a bottom on Oct. 9, 2002, and exactly five years later on Oct. 9, 2007, the bull market came to a screeching halt as the credit crisis reared its ugly head. While many stock traders knew something bad was unfolding, I knew what was happening long before.

These charts say it all. As you can see from this Wall Street Journal graphic, the S&P has made new highs after every sell-off/pullback all year. The index continues to turn bad news into good. The big question with the markets up so much is: Do they sell the news?

Click to enlarge image.

When the word "subprime" was still an obscure term used by a few mortgage lenders and financial engineers, I took a call at our desk above the S&P pit from one of the world's top independent traders, Marty "The Pit Bull" Schwartz. My old client and friend told me that there was "rotten wood" floating around in the brokerage and financial stocks, which were the market leaders. Little did the Pit Bull know that soon Bear Stearns and Lehman would fall, setting off one of the largest bear markets since the Great Depression.

With stock prices nearly doubling from 2002 to 2007, the 2007 peak set off some of the largest selling I had ever seen. Having a background in program trading, my desk on the floor has been part of every major stock market correction since the 1985 crash, but none of the sell-offs compared to the ferocity of the credit crisis. As the world credit markets seized up, so did the global stock markets.

On March 9, 2009, stocks made a low, and at the end of 2010 the United States stock markets firmed and stayed that way right into 2011. Not only did the U.S. take back its leadership role as the No. 1 stock market in the world, it also outpaced Brazil, Russia, India, and China for the first time since 2007.

Even after Standard & Poor's lowered the U.S. government credit rating in 2011, during fears of a government shutdown and default, the U.S. stock market has gained more than any other major stock market in the world with the S&P gaining more than 38%, an average of 11% higher than the rest of the world's stock markets.

This is nothing new. But what is new is the overall price action of the U.S. stock market. Despite the fact that many investors were shaken out of the stock market during the credit crisis, low interest rates and the government's unending quantitative easing programs have flooded the markets with unheard-of amounts of liquidity.

I firmly disagree with a recent prediction by Société Générale: In a few months, the stock market will drop 15% and go nowhere for years. According to Bloomberg, the median 2014 year-end target for the S&P is up another 13%, or S&P 1900. But we are not here to talk about 2014, we are here to talk about how stocks will close at the end of 2013.

The best six months for stock runs from November to April, and provided that the markets get past the historically turbulent month of October, I feel strongly that stocks will continue to push higher. Until the current price action in stocks goes from short-term sell-offs and "back and filling" to decisively making lower lows, we see no reason to jump in front of the pattern.

Our view from the largest S&P futures desk is based on order flow, not speculation. This is what we see: When the stocks start to sell off there are several reasons for it, but after they sell off it seems the same reason for selling becomes the reason for buying them back. In other words, the stock market eventually takes the fear and turns it into a buying opportunity.

We look at the most recent sell-off as similar to every other sell-off all year. We looked for prices to get overextended and oversold. We have a trading rule called the "bus too full." Last week selling dominated the first three days of the week and then another trading rule came into play: It takes days and weeks to knock the stock market down and only one to bring it back . It took the short sellers a few weeks to establish short positions and a few days to force them back in line.

As we head into the end of 2013 and until the overall price action of the stock market changes we still think stocks will push higher right into the end of the year. As always, we are not here to fight city hall, and if stocks are going up we want to go for the ride.

You may have noticed that nowhere does my analysis say that this is the way it should be, or that the stock market is reflecting real, value-based assessment of our economic policy. The bullishness of the stock market is not matched by real reason for optimism about our economic policy. But until the government can rise above the extremism of some members of Congress who put ideology before country, we live with unsustainable uncertainty and can't make any long-term forecasts for sure -- either about the stock market or the supermarket.

Our year-end prediction for the Dow is 15,800 to 16,000 -- uncertainty or no uncertainty.