I see this market unfolding according to script, "script" being what it does more years than not. There are no absolutes in the market, no guarantees. But many years unfold exactly as this one has, with a good rally continuing from the end of the previous year into the spring, hesitation, a pullback in the June Swoon, and a rally going into July 4th.
It's what happens next that is most important.
Every year people talk about "The Santa Claus Rally" and "The Summer Rally." Those are both misnomers, implying that the winter rally is centered on Christmas time and the summer rally extends throughout the summer. In fact, it has historically been rather the opposite.
The Santa Rally typically extends throughout the end of the year and the beginning of the next year -- beginning in November when people begin to anticipate (and often pre-spend!) any raises or bonuses, year-end special dividends, increases in COLA for those in government jobs or on pensions, etc. This wealth effect, along with the good feelings that come that time of year (or relief: "Well, we made it through another year!") often combine to provide a powerful rise in optimism looking to the next year and a consequent increase in investment.
The Summer Rally, on the other hand, doesn't really come to fruition. It is many times, instead, the Independence Day Rally. June is often so-so to awful, with a bounce back that seems stronger than it is simply because it comes from such a lower level. It often lasts the entire week up through the 4th or 5th of July, then falls apart as the climatic "Dog Days" in the northern latitudes meet up with the news-feed "Dog Days," as well as Wall Street disinterest in manipulation when there are so many more important things to do, like party in the Hamptons and buy that new helicopter so they can look down literally and figuratively on all the little people beneath them.
If this year goes according to script (and there is never, ever any guarantee of anything in this business!) we may expect a rally for at least part of this week, then an unraveling. With the euro-problems, U..S debt problems, stagflation, housing, unemployment, etc., all failing to line up like good soldiers, my best guess is that this year we'll see an unraveling as early as this week or as late as next. The strategy that follows, for me, is to say "thank you" as I sell some long positions into this rally and buy broad-brush ETFs like RWM, SBB, SEF, and UUP (see recent article here for more on UUP) -- and perhaps some TLT for good measure -- to benefit from, in the case of the first three, a declining market in what I consider three of the most overbought and shaky sectors, and in the case of the latter two, a flight to safety over the summer.
If this trade works out this year again – note I said "trade" because I refuse to remain too long positioned contra-optimism in a nation that is and usually has good reason to be optimistic about our future – we will have protected our clients during the decline and have fresh powder for whatever gifts Santa decides to bring us come November.
Disclosure: We, and/or those clients for whom it is appropriate, are long SBB, RWM, and UUP. We just initiated our first position in SEF and are looking at TLT if it falls to the 90-92 area. No positions there yet. We also have a good cash cushion, some covered calls, and tight trailing stops in place.
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