End of the Year Stock Market Movement
The Trader’s U E-Letter: Issue # 163
Wednesday, November 30, 2005
End of the Year Stock Market Movement: Santa’s Not Coming to Town… Just Yet
by D.R. Barton, Jr., Chairman, Trader’s U
I hope you had a chance to read Dr. Mark Skousen’s article on the “Santa Claus Rally” in the Investment U E-Letter earlier this week.
Mark makes a great case for this stock market phenomenon, which shows that, for a high percentage of years, stocks advance dramatically in the last two months of the year. And so far, since October, the historically proven end of the year stock market movement theory is holding out, with a nice rally up to and through the Thanksgiving weekend.
But whoa!… Before you jump right into the market expecting some significant gains in the coming month, put on the brakes… at least for a bit.
Will we get the rest of our Santa Claus Rally in the last week or two of the year? That’s a strong possibility. Could there be a better entry point for stocks in another week or so? Most likely.
But with the news that came out in the past week, the probability is low that stock prices will head higher in the near term. Let me explain…
When the Stock Market Doesn’t Believe the Numbers
On Monday, the holiday shopping news was great. The venerable Wall Street Journal’s lead article on the retail sector gushed “First Holiday Shopping Weekend Sets a Blistering Pace.” USA Today had a front-page story titled “Holiday Sales Dip Then They Dazzle.”
Leading up to “the biggest shopping weekend of the year,” commentators suggested that a strong weekend of retail shopping was just the tonic the market needs to extend its six-week rally.
And this past Monday morning, things were going according to plan. Strong retail sales numbers were reported – up 22% versus a year ago. The newspapers were trumpeting a triumph. And in pre-market trading, the S&P 500 futures contract was trading to new highs.
A Wrinkle in the “End of the Year Stock Market Movement” Phenomenon
But then a funny thing happened when the market opened. The stock market dropped…like a rock. And retail stocks dropped faster and harder than the broader market. A disappointing economic report on existing house sales added fuel to the fire, and the stock market headed lower for the rest of the day.
By early afternoon, the media spin doctors were out in full force. Stocks were down, they said, because sales were only strong at discounters like Wal-Mart, while shopping malls and specialty merchants were showing only modest results.
Yet Wal-Mart’s stock was down just as much as all of the other retailers. As you may have figured out by now, most of the reasons given in the media for stock market movement are just educated guesses.
To be honest, I’m not smart enough to know why the market reacted so badly to this positive retail sales data, either. But I am smart enough to get out of the way when it happens!
Good News + Bad Reaction = Near-Term Trouble
Here is a pattern that repeats itself over and over again in the markets:
- A significant news item occurs with a clear positive or negative implication.
- The stock or the broader market moves down on good news or up on bad news.
- Pundits put their spin on the reaction to make it sound like they understand it.
- The stock or the broader market continues in the contrary direction.
- Average traders and investors scratch their heads and wonder why they lost money when the news was on their side.
But we’re no average traders and investors. When the market tells us something significant, we listen. And the market is telling us something significant this week about the end of the year forecast.
How can we use this contrary reaction to our benefit? We can either climb on board in the direction of the contrary reaction if it is strong enough, or we can at least get out of the way for the near term and protect our capital.
Let’s look at the two criteria that can help us make a decision about how to react when the market doesn’t believe the news. Here are two questions to ask to help you make sense of contrary reactions.
1. Is the news really one-sided? It’s very important to understand the nature of the news that is being ignored, or even causing a move in the opposite direction. We need to make sure there is no “silver lining” in a bad news story or no downside to a good news story, because these items can explain the contrary reaction. For example, many times a company will come out with a good earnings report that beats expectations. But then the company will also lower its guidance for future earnings. This is a mixed message that could cause the stock to move either way.
On the other hand, there are events that have truly one-sided news. Hurricane Katrina was clearly bad news for near-term petroleum delivery in the U.S. There was no silver lining in that news event. Likewise, the current retail sales news from this past weekend had components that were either okay, good or great. There were no red flags in the report suggesting near-term or year-end movement. Yet, the retail sector and the broader market tanked.
2. Is the stock or the broader market stretched when the news occurs? This question is key to understanding the magnitude of the contrary reaction. If the stock or the market has had a strong up-move and is making new highs, then good news should be the fuel it needs to propel it higher. But if the price reaction goes against the good news, this can be the spark that fuels the correction of the overbought condition.
This is the exact reaction I saw when Katrina hit and oil prices spiked, then immediately retreated. Oil prices were already incredibly stretched to the upside, so when they lost ground when the news was supportive of higher prices, this turned into a tipping point for prices to make a long and serious retreat.
In the equities market, we’ve had a big move up over the past six weeks leading into Thanksgiving. The markets have stretched to four-year highs. Then we got a good retail spending report, and prices moved up a bit then immediately retreated. I told a conference call full of folks that this is a clear signal that we should get a further correction in prices. And we have.
How to Play the Santa Claus Rally
We’re at a place where the probabilities favor further downside for stocks. Jumping in now is most likely not the best entry. But if you like the idea of the Santa Claus rally, this may be a blessing in disguise. Here are two ways to play the waiting game and make more money:
- Allow the current price correction to run its course. Buying on pullbacks is a great way to get better entries for your trades and investments. You’ll know the correction is most likely over when we get a close above the highest high of the last two trading days.
- Just wait for new highs. Wait for the market to close above the old high of 1,170.64 in the S&P 500 cash index. Then you’ll be entering with confirmation that the old momentum has resumed. And what if we never break above the old highs? Then you will have saved yourself a bunch of cash by staying out of a market that is not going up.
Great trading,
D.R.
Today’s TU Tips & Tricks
- Whether you’re a trader or an investor, improving your entries is a great way to add to your profits. Trader’s U issues #140 and #141 were a two-part series that gave some sound instruction on getting better entries.
The Chart of the Week
The Retail Holder (AMEX:RTH) has been in an uptrend since making a triple bottom in late October. As today’s Trader’s U describes, it has been in a near-term pullback. It is now approaching its 20-day exponential moving average (an exponential moving average is designed to be faster-acting version of the simple moving average). Many technical analysts like to buy on a pullback to this broadly watched moving average. If you believe that retail sales will rebound and fuel the Santa Claus Rally, this is a good way to play the potential up move. For more information on exponential moving averages, go to http://stockcharts.com/education/IndicatorAnalysis/indic_movingAvg.html.
Related Articles:
- Santa Claus Rally: Is a Year-End Stock Recovery Coming to Town?
- Where To Invest Your Money NOW…When Your 15% Investment Tax Is On the Line
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