Is A Santa Claus Rally Underway?
The first trading day of December started off with the Grinch in control of stocks. Only a day later stocks rallied and accomplished a follow-through day and as the month progressed stocks continued the rally that was launched from lows hit in late November as shown in the chart below.
It is not surprising that stocks have advanced this month; December is historically a strong month for stocks and has often been associated with "Santa Claus Rallies". My job is to determine if this is more of a bear market rally or the start of a new bull market. With horrible economic news arriving every day only to be compounded by the biggest Wall Street scandal ever, it is hard to believe stocks can rise in this environment. Despite the headlines stocks are holding ground, even advancing. It helps to remember the stock market is forward looking by many months and should start a recovery in advance of any evidence of improved economics.
The current rally has been able to avoid distribution days, described as a day when prices fall but volume increases from the previous trading day. Unfortunately this cannot be said of foreign markets. While many of the Asian markets are up aggressively since this rally began in late November (iShares FTSE/Xinhua China 25 Index Fund is up 47% since November 20th), the Shanghai exchange has experienced three distribution days during the period, Hong Kong exchange four.
I believe this rally will ultimately fail for the several reasons. The start of a new bull market will involve more volume. Stock leadership is another component that is missing for the current rally. There have been some improvements but not enough to bank on. In the early stages of a new bull market many leading growth stocks break out into new price territory and that is scarce in the current rally.
From a fundamental perspective, I believe stocks are going to find it difficult to continue to appreciate until credit markets improve and the financial sector has completed the deleveraging process.
Another troubling development in the current rally is the price action in U.S. Treasury Bonds. They are soaring in price. This is a sign investors are still very uncertain about the future for stocks along with a deflation concern. During bull market rallies money leaves the safe haven of bonds and is invested in stocks, which does not appear to be happening in this market. Today we see so much money going into Treasuries that real yields have been pushed into negative territory (interest rate - inflation). 10 year Treasury bonds are yielding approximately 2.63% and inflation is currently listed at 3.66%, creating a yield of -1.03%. Take a look at the price action and pick-up in volume for the iShares 20+ Year Treasury Bond Fund.
We are not left completely void of opportunities in this market and selective entry into a few areas makes sense given the number of months and magnitude of declines in this bear market. The drop in crude oil has presented some unique opportunities and metals/mining stocks have performed very well over the last month. The ability for stocks to hold up in the face of some terrible economic news lately is impressive and it is possible stocks could move into a confirmed bull market from these levels. There are also some interesting opportunities in debt market and dividend stocks worth reviewing. For this reason I believe careful moves back into the market makes sense.