S&P 500 Up 27% ... Why Stop Now?

by: Danny Riley

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The S&P 500 [^GSPC:SNP] roared to its 42nd new all-time contract high in 2013 during last Friday’s trade.

An unexpectedly strong report showing the U.S. economy grew by an annual rate of 4.1% from July to September, the December quadruple witching, the S&P rebalance and Facebook (NASDAQ:FB) being added to the S&P all helped push the major indexes to new highs.

Most of last week’s gains came on Wednesday after the Fed said it was going to start to “taper” its economic stimulus program.

Fed taper

FOMC meeting schedule S&P 500 up 27% ... why stop now?

The S&P 500’s 27% gain will probably not be put to the test anytime soon, but it will be tested. Most economists now believe the Federal Reserve will start to reduce its bond purchases by $10 billion a month over the next seven meetings. The meetings occur roughly every six weeks and we predict that they will become the most important events the markets will face in 2014.

While the Federal Reserve’s surprise $10 billion reduction was a big positive for the stock markets, investors will be watching Wall Street very closely in the months ahead. The true test of the S&P will be down the road as the Fed continues its taper process and all the liquidity provided by the Fed will be removed.

Jeffrey Hirsch from the Stock Trader’s Almanac believes the market will continue to hold during the best six months for stocks, November to April, then pull back, and then start moving back up.

In the end the Fed’s balance sheet has jumped to a record $4.01 trillion as of Dec. 18, up $2.82 trillion from when the Fed began its third round of purchases. The Fed balance sheet is expected to expand to $4.4 to $4.5 trillion by the time the program concludes with total purchases for QE3+ equaling $789 billion in Treasuries and $800 billion in mortgage bonds.

Volatile 2014

Keeping rates low has worked. The stock market has gone up and the economy is recovering. The test of this will be in 2014 as the Fed pulls back. The main trigger point is still the lack of jobs. While the November jobs report showed 203,000 and the unemployment rate fell to a five-year low of 7%, the real problem facing the U.S. economy is job creation, which remains elusive.

The test of the markets will be what happens to stocks as the Fed pulls back and job growth dips. While we remain bullish, we also think it’s prudent to expect some type of sell-off in 2014. In order for the U.S. economy to get back to its pre-credit-crisis employment, it would have to support 360,000+ jobs a month for an extended period of time. We just do not see that happening anytime soon.

Year-end historical patterns

There are 6 trading days left in 2013. The stock market has been “supercharged” by low interest rates.With so little time left we expect traders to pull back. Most big funds, banks and prop trading desks let people take a few extra days off before and after the holidays. All prefer that the year ends without any surprises.

According to the Stock Trader’s Almanac, the last trading day before Christmas has the Dow up 5 out of the last 5 and the last trading day of the year has the Nasdaq up 11 of the last 12, and up 29 in a row from 1971 to 1999. We think the year will end in what we call “thin to win.”

Santa Claus rally

MrTopStep has watched for the Santa Claus rally for the last 28 years. While some traders don’t pay much attention to the “seasonalities,” we do. Historical stats are a big part of our trading toolbox and always have been. For those traders who are still trading at year end and have never paid attention to history, we suggest you do.

There are a lot of moving pieces, but let’s narrow it down a bit: The idea is to start buying on the final two days of December, Monday, Dec. 30, and Tuesday, Dec. 31, and hold until Friday, Jan. 4, for an average gain of +1.5% for the S&P since 1953. However, if Santa should fail to call. the bear may come to Broad and Wall. Santa’s failure to show tends to precede bear markets or times when stock can be purchased at lower prices later in the year. To learn more, please click here.

The Asian markets closed mostly higher and Europe is trading mostly higher as well. This week’s holiday economic schedule includes six T-bill or T-bond auctions or announcements, 16 separate economic releases, Thursday’s CME and NYSE early close and Wednesday’s Christmas holiday. Today’s economic calendar starts out with the personal income number, Chicago Fed National Activity Index and consumer sentiment. This week should be extremely slow; today is a full day and tomorrow the S&P will close at 12:15 CT.

Here are links to the CME Christmas and NewYear’s trading schedules (PDF):

Our view

The last 5 days of the year and the first 2 days of the new year tend to be bullish, but after an almost 60-handle rally in less than two days we think there is also a possibility that today resembles last Thursday, a kind of sideways to down day.

Mondays have not been kind to the S&P, and with tomorrow’s stats showing it as a down day we think it’s important not to get ahead of the market. Remember, if Santa comes to Wall Street, it’s not until till the last two trading days of 2013 and first two of 2014, which is not today or tomorrow.

We lean to higher prices, but we also think if you’re trading you should be a lot more patient. Things are going to get mighty thin over the next 6 days.

As always, don’t forget the 10 handle rule and please use stops …

  • In Asia, 9 of 11 markets closed higher: Shanghai Comp. +0.24%, Hang Seng +0.48%, Nikkei 0.07%
  • In Europe 10 of 12 markets are trading higher: DAX +0.67%, FTSE +0.62%
  • Morning headline: “S&P 500 Futures Up 27% With 6 Tradings Days Left In 2013 ”
  • Total volume: 1.36mil ESH and 10.7k SPH traded
  • Economic calendar: Personal income, Chicago Fed National Activity Index, consumer sentiment and earnings from CALAMP.
  • E-mini S&P 5001822.25+7.75 - +0.43%
  • Crude98.55-0.22 - -0.22%
  • Shanghai Composite0.00N/A - N/A
  • Hang Seng22921.561+109.381 - +0.48%
  • Nikkei 22515870.42+11.2 - +0.07%
  • DAX9464.79+64.61 - +0.69%
  • FTSE 1006661.64+55.06 - +0.83%
  • Euro1.3705

 S&P 500 up 27% ... why stop now?