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Some say the stars are aligned for a so-called Santa Claus rally.
That refers to a rise in the stock market in the last week of December and the first two trading days of January. The reason is that low liquidity makes it easier to push up the market. Last year was an exception when the stock market plunged in December.
It’s important for investors, however, to consider different viewpoints.
Let’s do that by reviewing a chart. Please click here for an annotated chart of S&P 500 ETF SPY, -0.90% which tracks the benchmark S&P 500 Index SPX, -0.88%.
Note the following:
• The chart shows three points when the relative strength index (RSI) was overbought on a weekly chart.
• The chart shows that for each of these three points, the volume was low.
• The left-most point on the chart shows a rise, similar to the one happening now, in the stock market. This rise was followed by a decline.
• The point in the middle shows a rise similar to that in the stock market now. This rise was followed by a big decline.
• The chart shows the Arora buy signal given right at the bottom of the last decline.
• The chart shows that the Arora long-term portfolios were up to 62% protected prior to the big drop.
• The chart also shows a short-term trade in Nasdaq 100 ETF QQQ, -1.47% on leveraged ETF SQQQ, +4.36% to profit from the decline.
• The right-most point shown on the chart is for the current stock market. The rise in the stock market, overbought RSI and low volume are similar to the last two times shown on the chart. During the last two times, the rise was followed by a decline. This is a big negative.
• An overbought stock market tends to be vulnerable precisely at a time when not many see a good reason for a decline, as is the case now. This is a caution flag.
• Performance chasing is on. In performance chasing, lagging money managers tend to throw caution to the wind and buy strong-performing stocks in an attempt to catch up with their benchmarks. This is a big part of buying that is occurring in mega-caps such as Apple AAPL, -1.28%, Amazon AMZN, -1.85%, Facebook FB, -1.66% and Microsoft MSFT, -1.68%. Semiconductors have been great performers. Stocks such as Intel INTC, -0.46%, AMD AMD, -0.83%, Micron Technology MU, -1.48% and Applied Materials AMAT, -1.80% may see more buying by lagging money managers. This is a positive. For details, please see “‘Performance chasing’ and Trump’s impeachment process could push the Dow to 30,000.”
• A big part of tax-loss selling is already done. This is a positive.
• Investors with large gains in taxable accounts are reluctant to sell before the year-end because they do not want to pay capital gains taxes this year. This is a positive.
• If the momentum in the stock market reverses, those with large gains, especially hedge funds, may want to sell to lock in profits. Such selling may accelerate the downward momentum. Looking ahead, this is a caution that investors should keep a careful eye on.
• There is a significant amount of economic data ahead, including the jobs report this Friday. The data have the potential to cause a short-term blip.
• The stock market is fixated on the phase one of a trade deal with China. Dec. 15 is an important date when new tariffs are scheduled.
• The stock market is assuming that, at a minimum, the new tariffs will be postponed and perhaps the trade deal with China will be reached before Dec. 15.
• So far China does not seem to be tying the U.S. support for Hong Kong to the trade deal. China sees U.S. support for Hong Kong as interference in its internal affairs. This may make China demand more concessions from President Trump, and Trump may not be willing to grant such concessions. If a trade deal is not reached and new tariffs are implemented, look out below.
• There is no parallel to last December in terms of the Federal Reserve. Last year the Fed was in the mode of increasing interest rates. Now the Fed is on hold. The primary reason for the big drop in the stock market last year was Fed tightening.
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Dow 30,000 magnet
Historically, big, round numbers have acted as a magnet for investors.
When I gave a buy signal on Trump’s election at a time when many were predicting a big stock market drop, it was at first met with incredulity. When I called for a high-probability scenario of the Dow Jones Industrial Average DJIA, -0.81% hitting 30,000 points in Trump’s first term, I received a ton of hate mail. I have subsequently repeated that call several times. Please see “Here’s the case for Dow 30,000 in Trump’s first term.”
Dow 30,000 is the next magnet.
What does it all mean?
Make no mistake that this stock market is controlled by the momo (momentum) crowd. Buying is taking place not because of better earnings, a better economy or better geopolitics, but because of the upside momentum. Keep in mind that the momo crowd is fickle and can turn on a dime. Investors ought to consider following a proven adaptive model, such as the ZYX Asset Allocation Model that has performed well in both bull and bear markets. This is also a good time for investors to take advantage of short-term trades as opportunities arise in addition to long-term positions.
With the Dow 30,000 magnet, many long-term investors may choose not to sell until that level is reached. When there is a dearth of sellers, the path of least resistance for the stock market is up.
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.
