The Bull Run Begins…
Prior to last week, the stock market was concerned about the looming fiscal cliff, with the Dow losing 1,070 points, or 8 percent over the last two months, and some sectors like utilities and other high-dividend stocks, down 11 to 18 percent.
The markets clearly viewed the election results in a negative light by selling off 6.3 percent in eight trading sessions. Obama's victory guarantees higher taxes going forward. Therefore, many people are rebalancing their portfolios to take advantage of the tax laws as they stand in 2012. That answers some of why the decline occurred.
However, commercial traders greeted the sell-off in the markets with open arms. (Commercial Traders describes traders that use the futures market primarily to hedge their business activities.) Commercial Traders in the Nasdaq and Dow Jones were major buyers, doubling their net long position in the Nasdaq and increasing their position in the Dow Jones by more than 50 percent! The major surge in commercial buying has pushed momentum back in favor of the bulls.
And heading into this week the market rallied sharply, the Dow up 3.2 percent last week alone, reflecting mounting confidence that politicians are coming to their senses and will succeed in hammering out a compromise that will either resolve the fiscal cliff threat, or more probably succeed in kicking it down the road to next summer.
So the market has been able to pay more attention to the economic reports. And it has additional support factors at this time.
The market is now in its favorable season; the winter months, where over the long-term it tends to make most of its gains each year!
There are also signs that corporate managements have become believers again. Corporate insiders, who have been selling heavily, seem to have returned to the buy side. According to Vickers Insider Report, near the market high in September insiders were selling heavily into the market strength, with the insider sell-to-buy ratio just about double its average sell ratio of the last ten years. But last week insiders had moved sharply to the buy side again, the sell-to buy ratio dropping to less than half its long-term average.
That seems to also tie in with investor sentiment as measured by the weekly poll of its members by the American Association of Individual Investors (AAII), which is considered to be a ‘contrary’ indicator. That is, unlike corporate insiders, who tend to be bearish and selling at rally tops, and bullish and buying at correction bottoms, individual investors tend to have ‘contrary’ sentiment, very bullish at rally tops, and bearish at correction bottoms. This is one of the primary reasons that it is more accurate to follow the commercial traders, rather than the small speculators.
For instance, as the correction from the mid-September top accelerated to the downside, the AAII poll reached a level of 48 percent bearish on November 11, just over two weeks ago. That was just days before last week’s rally began. The last time the AAII poll was 48 percent bearish was on September 22 of 2011 (last year), just as the big rally of October to May got underway last winter and saw the Dow climb from 10,500 to over 13,200!
Technically speaking, there are two key points. First of all, the two month sell-off we have experienced pushed us to a new three month low. Secondly, the bullish reversal the market pulled on November 16th provided indication of a major rejection of that low. The rally on November 19th was so strong that 90 percent of roughly 2,800 stocks traded on the NYSE closed higher. That kind of rally provides a statistically valid bottoming signal. Merrill Lynch was the first to capitalize on the statistical relevance stating that since 2006 there have been 1,733 trading days and this type of day has been observed only 62 times. The relevant pattern is that we should pause for a couple of days before resuming our climb through the 10, 20, 30 and 65 day moving averages.
One last piece of evidence of the rejection of the new three-month low made on November 16th is that the market immediately opened 0.5 percent higher and continued to climb another 1.5 percent for the day. The strong rally off the multi month low has only occurred 9 times since the Daily Sentiment Report has been tracking this and their research shows 7 of the 9 led to multi week bull runs. The two that didn't pan out were both in the months following the tragic events of September 11th.
The U.S. economy can’t offset deteriorating global economies for the long-term, and may run into problems of its own next year. But it looks like a window of opportunity exists for a typical favorable winter season rally to next spring, and for our members, this could be the beginning of some very strong potential returns ahead.