TRADERS ARE BUYING IN ANTICIPATION OF YEAREND SANTA CLAUS RALLY -- JANUARY EFFECT STARTS BOOSTING SMALL CAPS IN MID-DECEMBER -- WE'RE NOW IN THE SWEET SPOT OF THE MIDTERM ELECTION CYCLE -- AND FOREIGN STOCKS ARE REBOUNDING
SANTA CLAUS RALLY IS STILL AHEAD ... The stock market is benefiting from a number of seasonal trends which should last well into the new year. For one thing, the month of November starts the "best three months" span that lasts into January, and the "best six months" span that lasts into April. December itself is historically the best month for the S&P 500 and the second best for the Dow and Nasdaq. And the second half of the month is usually stronger than the first. There are at least two reasons for that. The first is the so-called Santa Claus rally which is usually concentrated during the last five trading days of the year and the first two in January (according to the Stock Traders Almanac). Traders usually buy in anticipation of that yearend boost, as they appear to be doing this year. The three charts below show the Dow, Nasdaq, and S&P 500 indexes continuing the strong rebound that started yesterday (Wednesday). Since traders buy in anticipation of the yearend boost, the Santa Claus rally often starts at mid-month. So does the so-called January Effect.
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Chart 1
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Chart 2
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Chart 3
JANUARY EFFECT NOW STARTS IN MID-DECEMBER ... The so-called January Effect is the tendency of small caps to outperform large caps during January. According to the Stock Traders Almanac, however, the January Effect now starts in mid-December. Small caps start doing better during October, but really take off in mid-December. They often hold that lead until the following May. Chart 4 shows the Russell 2000 Small Cap Index nearing a test of its November high and on the verge of an upside breakout. The S&P 500 is still 2% from a new high. The RUT/SPX ratio on top of chart shows small caps starting to do better during October and December which fits the seasonal pattern. Their stronger performance usually starts during the middle of December (this week). They appear to be rallying on cue. That also supports the stock market through yearend.
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Chart 4
FOURTH QUARTER IS SWEET SPOT OF MIDTERM CYCLE... The Almanac points out that the fourth quarter is generally the best quarter of the year for stocks. Additionally, fourth quarters are even stronger during a midterm election year (like 2014). That cyclical strength usually lasts through the first quarter of the following year (2015). We're now right in the middle of that "sweet spot". While crude oil and energy shares appear to be stabilizing, and foreign stocks rebounding, the chances for the traditional yearend rally look pretty good. Chart 5 shows the Vanguard FTSE All-World ex-US ETF (VEU) bouncing off potential chart support along its mid-October bottom. That's the first encouraging chart action since late November. A lot of the new buying is coming from Canada (shown yesterday), Europe, and Japan. Even some emerging markets are starting to stabilize. [The VEU has a 25% weight in emerging markets). The VEU has a long way to go to reverse its current downtrend. But this week's rebound could be a sign that foreign selling has been overdone. Any new stability in foreign markets would take a lot of pressure off the U.S., and is one reason why traders are buying U.S. stocks so heavily. Added to that, the Fed gave the markets a nice Christmas gift yesterday with its promise to be "patient" raising rates during 2015.
