Markets Set To Rally?

Stocks have now advanced between 4-5% since their lows on November 15.  They are up against resistance but nowhere near overbought.  The question becomes where do we go from here.

The market staged a massive reversal yesterday.  Stocks went from generally down about 1% to closing up about the same amount by the end of the day.  Two things seemed to have engaged the animal spirits around mid morning.  The first was generally conciliatory talks coming out of Washington regarding the budget negotiations.  Also word leaked that the Federal Reserve was seriously thinking about doing another round of quantitative easing.  The reporter who brought this story, the Wall Street Journal's Jon Hilsenrath, is widely considered to be the current mouthpiece of the Federal Reserve.  Thus this story had the capacity to move things.  

Going forward while stocks may continue to react to the "fiscal cliff" debate, stocks seem to have the capacity to move higher between now and year end.  Economic data such as autos, housing starts and consumer spending continues to support a growing economy.  The elections have provided clarity and closure for the time being.   Stocks are also trading at reasonable valuations by our work.  Perhaps the most important consideration right now though is seasonal.  We are fast approaching year end and many institutional investors and hedge funds have underperformed in 2012.  One can assume that there will be pressure on them to chase performance in the last five weeks of the year.  In short things seem to be in place for a Santa Claus Rally between now and December 31st.  In response to this, we have generally taken down our cash positions in client accounts depending on our strategies and per individual client  risk/reward parameters.  We think stocks on a risk/reward basis turned much more attractive around mid month.  That's when we changed our intermediate market indicators and our shortest term indicators to NET MARKET POSITIVE.  

We are mindful that any setback in the negotiations in Washington could derail the markets.  I will also state that I don't believe that a complete deal is necessary by December 31st.  I think a stopgap measure with a promise for a more complete accord in the new year will be enough to placate investors.  Absent this and absent an unexpected event coming over the transom between now and year end, stock market action has the potential to be positive between now and then.  If for no other reason that the most important print of the year is the last one on the last trading day of the year.  Professional investors have a powerful incentive to move markets higher between now and then because that's how so many folks get paid.  That at the end may trump everything else.