SEASONAL PATTERNS FAVOR THE BULLS - DOW HITS CHANNEL RESISTANCE - SHORT-TERM RATES REMAIN WAY DOWN - LONG-TERM RATES RECOVER - A STEEPER YIELD CURVE - REGIONAL BANKS LAGGING BIG BANKS

SEASONAL PATTERNS FAVOR THE BULLS ... Link for todays video. According to the Stock Traders Almanac, the best six months of the year are from November 1st to April 30th. The Almanac provides a performance table going back to 1950. Being long stock indices for these six months and switching to fixed income from May to October provided good returns with less risk. Less exposure to stocks means less risk and a higher risk-adjusted return. Over the last 59 years, from November to April, the Dow has been up 45 times and down just 14 times. Since 1950, the average November-April gain in the Dow was around 7.5%. In contrast, the average gain for the May-October period was less than 1%. Those are pretty good numbers that bode well for the next 5-6 months.

Chart 1

Chart 1 shows the Dow Industrials with the six month seasonal pattern. The green lines and arrows represent buy points at the beginning of November, while the red lines and arrows show sell points at the end of April. Results for the last four 6-month cycles are mixed. Notice that the Dow declined during the normally bullish November-April period in 2007-2008 (yellow area). The Dow also advanced during the normally weak May-October period in 2009 (orange area). Even though these two periods went against the normal 6-month cycle, investors selling in May 2008 would have avoided the plunge from 13000 to 8500. That alone may have been worth the price of admission.

With November underway, the Dow has entered a historically bullish six month period. Even though the Dow is already up over 7% this month, there could be more positive seasonals ahead. The Almanac also notes that the Dow advanced the week before Thanksgiving 13 of the last 15 years. Furthermore, Jeffrey Saut of Raymond James notes that the Dow has been up from November 11th to December 5th each of the last 12 years. Even during last years massive decline, the Dow managed a bounce from mid November to early December. For those with further interest, the 2010 Stock Traders Almanac is available at the Stockcharts.com bookstore.

DOW HITS CHANNEL RESISTANCE... Even though all these seasonals point to further strength into yearend, we must still keep our eye on the chart for confirmation and risk-control. Chart 2 shows the Dow Industrials moving from the lower left to the upper right, a clear up trend. After a sharp surge in July, the Dow then started zigzagging with higher highs and higher lows. Pullbacks occurred soon after each higher high, but each pullback resulted in a higher low. The uptrend remains in place until this string of higher highs and higher lows is broken. With the Dow currently trading above its October high and the Average up over 7% in 13 days, the odds favor a pullback or consolidation. First, notice that the Dow is near potential resistance from the upper channel trendline. Second, notice that the 13-day Rate-of-Change is above 5% for the third time since September. The last two reaction highs occurred after similar surges. At this stage, the most I am looking for is a pullback within a bigger uptrend.

Chart 2

SHORT-TERM RATES REMAIN DOWN - WAY DOWN... Despite the March-November advance in stocks, the 3-month Treasury Yield ($IRX) remains at extremely low levels. Chart 3 shows $IRX breaking down after the Lehman debacle with a plunge below .5% (5.0 on the chart). The yield moved below .3% and has remained below this level for over a year now. Such low short-term yields weigh on the Dollar because there is little return for holding money in Dollars. Low short-term rates also confirm that the Fed is not ready to raise rates anytime soon. Look for the 3-month Treasury Yield to break above this years highs to signal a potential change in Fed policy that could provide a lift for the Dollar. Until then, low short-term rates are likely to continue weighing on the Dollar. Chart 4 shows the US Dollar Index ($USD) and the 3-month Treasury Yield falling since March.

Chart 3

Chart 4

LONG-TERM RATES REBOUND AFTER LEHMAN... In contrast to short-term rates, long-term rates moved back to pre-Lehman levels. Chart 5 shows the 10-Year Treasury Yield ($TNX) holding 3.4% (34 on the chart) after Lehman, but then plunging below 2.2% in November-December. However, instead of remaining at low levels this year, the 10-Year Treasury Yield advanced back above 3.4%. This coincided with a rather sharp decline in bonds. Remember, bonds fall when rates rise and visa versa. Since breaking back above 3.4% in late May, the yield has hovered around this level with a falling channel taking shape. Even though this channel looks like a mere correction after an advance, the trend since June is down as long as channel resistance holds.

Chart 5

A STEEPER YIELD CURVE... With the 10-Year Treasury Yield ($TNX) around 3.37% and the 3-month Treasury Yield ($IRX) around .30%, the yield curve is as steep as it has been in a long long time. Most of this steepness stems from the steady decline in short-term rates. Regardless, a steep yield curve is a potential boon for banks. At the very least, banks can generate income by borrowing short-term and lending long-term, provided they lend. The spread, or yield curve, represents their profit. The steeper the yield curve, the steeper the profit potential. Chart 6 shows two snapshots from the Dynamic Yield Curve. The yield curve was fairly steep at the end of last year, but became a lot steeper in 2009.

Chart 6

REGIONAL BANKS LAGGING BIG BANKS... While it seems that the steep yield curve would benefit regional banks, this is not evident in the charts. Chart 7 shows the Financials SPDR (XLF) surging from March to May, correcting from June to July and then moving to a new high in October. The big banks that dominate XLF are clearly benefiting from Fed policy. XLF established support around 13.5-14 in August and this level continues to hold. XLF remains in a clear uptrend as long as this support level holds. Despite some relative weakness in November, it would be premature to turn bearish before a support break.

Chart 7

Regional banks have not faired as well as big banks. Chart 8 shows the Regional Bank SPDR (KRE) surging March to May, correcting June to July and then failing to exceed its May high. After meeting resistance just above 23, KRE declined the last 3-4 months and is underperforming the S&P 500. Despite relative weakness, the decline looks like a big correction. In fact, it looks like a less steep version of the May-July correction. The current wedge retraced just over 62% of the July-August surge and KRE is finding support around 20. A break above 22 would signal a continuation of the July-August advance and target a move above the May-August highs. This is perhaps the most important group to watch right now. A breakdown in KRE would be detrimental to the market overall, but an upside breakout would provide a bullish boost.

Chart 8