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'Santa Claus Rally' May Be Running Out of Steam

Sunday, 12 Dec 2010 01:24 PM

 

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The December rally may be reaching its climax, with just two weeks to go before Santa Claus makes his midnight run. Dwindling volume, excess optimism, and history all point to a stock market that could be running out of steam.

Investors appear to have grown complacent as the CBOE Volatility Index, or VIX, has fallen to levels not seen since April. Stocks have made new highs on almost a daily basis. The S&P 500 closed Friday at its highest level since September 2008 and the Nasdaq scored its best finish since late December 2007, with many expecting gains to run through the end of the year.

But Cleveland Rueckert, an analyst at Birinyi Associates in Stamford, Connecticut, believes the year-end rally may be largely done.

"The majority of that gain may already have occurred," he said. "Most people are more likely to be closing out their books at the end of the month and looking for opportunities to open new positions at the start of the next month."

Rueckert said that over the last 65 years, when the S&P 500 has rallied at year's end, the average gain has been 3.4 percent between Thanksgiving and New Year's. So far, the index has risen 3.5 percent since the start of the period.

"A lot of stocks this year have had very big gains and it really wouldn't be surprising to see a lot of the managers close out positions and take some vacation time," he said.

Monday starts the last five-day trading week before Christmas. The following week will be cut short by the holiday. With Dec. 25 falling on Saturday this year, the U.S. stock market will be closed on Friday, Dec. 24, in observance of the Christmas holiday.

Inflation data for November will dominate the week's economic calendar, with the U.S. Producer Price Index due Tuesday and the U.S. Consumer Price Index set for Wednesday.

BULLS IN THE EGGNOG

Some see signs of the bulls getting into the eggnog.

The American Association of Individual Investors' latest sentiment survey shows bullish sentiment reached a four-week high. What's more, bullish sentiment has spent 14 weeks above its historical average -- its longest streak in six years.

That is often seen as a contrarian indicator.

Last week, the S&P 500 broke through closely watched resistance levels and climbed for six of the last eight days to close at new two-year highs.

But gains have been accompanied by decreasing participation. Average volume during the last three days of the week was 7.76 billion, well below this year's daily average of 8.62 billion.

"We are entering now the beginning of the seasonal pattern where volume really dries up," said Nicholas Colas, chief market strategist at the ConvergEx Group in New York. "It seems like it's starting a little sooner than usual.

"I don't think we're at any risk of a meaningful sell-off into the end of the year, but I think the basic contours of what the economy looks like are pretty well set," he said.

That sentiment was reflected in the VIX, also known as Wall Street's favorite barometer of investor fear. Although the VIX edged up Friday, the index has fallen for six of the last nine sessions. It now stands at 17.61 after hitting its lowest since April.

The 15-day moving average of the advance/decline ratio on the New York Stock Exchange, a measure of the proportion of advancing to falling stocks, has started to slip and currently stands at around 1.5. It peaked this year in July at about double that, according to Reuters data.

In addition, the three-day moving average of stocks making new 52-week highs has also turned lower after a spurt at the start of the month. It now stands at around 125, down from more than 250 at the beginning of the month.

The breadth and ratios have not been "on board" this rally of late, according to a report from McMillan Analysis Corp. Equity-only put-call ratios remain on "sell" signals, the analysts say.

Chart-minded investors are bullish. The S&P 500 has closed well above 1,228, the 61.8 percent Fibonacci retracement of the 2007-2009 bear market slide, a key technical level.

"When a market surpasses a certain retracement level, then the probability increases of a rise to the next retracement level, which in this case would be a 76.4 percent retracement and that's a ways up at 1,362," said Chris Burba, a short-term market technician at Standard & Poor's.

The 1,120 level, the top of a recent trading range, is seen as strong support.

On Friday, the S&P 500 closed at 1,240.40. It was up 1.3 percent for the week.

An agreement to extend the Bush-era tax cuts over the next two years has started to seem like less of a done deal. The agreement is likely to be passed by the Senate on Tuesday, but may face a tougher road to passage in the House.

If the legislation stalls, resulting in higher capital gains and dividend taxes at the start of next year, then U.S. stock prices could fall.

The Federal Reserve's policy-making body, the Federal Open Markets Committee, will convene Tuesday for its last meeting of the year. The recent clutch of stronger economic data could spark a debate over how far to stretch the central bank's $600 billion stimulus plan, designed to keep interest rate low through bond purchases.

"The hawkish members on the Fed may seize on this cluster of strong numbers and use them to support the argument against" quantitative easing, said Pierre Ellis, senior global economist at Decision Economics in New York.

© 2014 Thomson/Reuters. All rights reserved.

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