Christmas bells will be ringing in the weeks ahead. Joyous tidings will be on everyone’s minds, but this is also the time for investors and traders to look ahead, re-examine strategies, and prepare, hopefully, for a “Santa Claus rally”. Financial markets are also settling in for a long Winter’s night, ranging within tight boundaries, but will there be a Grinch on the horizon, ready to steal away our presents, or will a sugar plum fairy appear and dance to music that sounds like drops of water shooting from a fountain?
Tchaikovsky may have created the latter, his famous pas de deux for his principal female ballerina in The Nutcracker, but he was focused on entertaining his adoring audiences in Paris in 1891. Fast forward to the present day, and we might be just a tad more interested in what might happen to our open positions in the market, than whether Clara and the Nutcracker Prince will make it to the magical Land of Sweets.
What are the major themes that will shape market behavior over the remainder of this year and influence price action on into 2016? Pundits have already beaten to death the probable impacts of a Fed increase in interest rates. Will it be in December or January or later? And by how much and over what period of time? “Yes” and “gradually” are the prevailing sentiments at the moment, but what other notions are out there, guiding the investment planning of the so-called experts? Here are just a few ideas to ponder.
How does the final quarter of the year rate on an historical basis?
Believe it or not, the fourth quarter of the year has been the banner performer over the previous 25-year period. The latest statistics gathered over this period for the S&P 500 have been stellar. Would you believe that the cumulative gains have been 253%? The entire nine months from January to September have only netted out at 181%, meaning that the Holiday Quarter has not only been a breadwinner, it has also beaten the rest of the year hands down. Perhaps, there is a reason to believe in a “Santa Claus” rally.
Will this trend continue in 2015? The majority of analysts are predicting that it will, even though last week was a bummer of sorts and even though the Fed might get up the courage to hike its benchmark interest rates right before Christmas Day. These same analysts are claiming that last week’s decline was more about commodities and deflation, and, as for the Fed, most believe that the expected 25 basis-point hike has already been baked into market valuations. The days of uncertainty and related volatility are not behind us, but a gradually improving trend might stick around for a while.
Has this six-year Bull Market finally run its course?
There have been so many “the-sky-is-falling” scenarios posted in the press that they now most definitely resemble the little boy that cried wolf. The S&P 500 was supposed to crater over the summer months, falling some 30-40%, but it did not. China was supposed to collapse and bring the rest of the world with it. It did not. Arcane OTC securities and sovereign debt issues were supposed to cause a liquidity crunch of monstrous proportions, but, once again, it did not happen.
And the doomsayers did not stop there. Price/Earning ratios, adjusted or unadjusted, are sky-high and ready to take a big fall. Nada! Market cap ratios to GDP were supposed to be at their limit, but, you guessed it – nada, again. This earnings season was supposed to be the final death knell for equity valuations, but, excepting energy stocks, the remainder of companies performed very nicely at a 5% increase clip in year-over-year earnings. The shot to be heard around the world was never fired. It did not happen!
You get the picture. Bears have been running at the mouth for six years, but nothing has brought this Bull to its knees. As one pundit reports, “Corporate profits are just shy of all-time highs, auto sales at record levels, housing is strong, the services sector is fine, etc. I could go on and on, but typically that has been ignored. No one was going to pay attention to that when fear was rampant. In fact, the bears have not paid attention to that for 6 years.” In fact, this market has been more about the ignorance of Bears and their inability to commit their un-invested capital, gathering moss on the sidelines.
Yes, fear has been rampant, but markets rarely top out when people are most fearful. The reasons for this fear are obvious. You only have to review the countless number of published articles that claim that our present situation is an exact repeat of 2008 to arrive at this conclusion. But the Bears continue to roar. Sooner or later, they will be correct, but like the proverbial hockey-stick chart, they keep moving the end of the stick to the next year. Presently, the forecast is for 2016, which may soon become 2017, if not. One great quote to remember is that, “In investing, what is comfortable is rarely profitable.”
Is anyone predicting a U.S. or global recession in the coming year?
The Bears may raise their hands in unison, but the experts see only a 5% probability of a recessionary trend in the coming year. China, even with all of their problems, is aiming for 6.5% GDP growth, and the Euro Zone, which cannot seem to get off the pot these days, just posted a 0.3% GDP gain of its own for the previous quarter. Miracles can happen, but countries now have to adjust to a gradually growing, incredibly inter-twined global economy that is not capable of enormous bursts of energy in any region of the planet.
Investment euphoria and over exuberance have not been present, the precursors of a precipitous fall in equity values. As one analyst has continually pointed out, “Bear markets occur either concurrent with a recession or in the aftermath of excessive bullish sentiment.” The signs of a recession are not there, and investor participation in this Bull market has been anything but excessive. The capital outflows from ETFs and mutual funds have been constant after the Great Recession. The average investor is just not enamored with stocks, even though the S&P and other indices are hitting all time highs.
Is all the hand wringing over commodity prices warranted?
There have also been a considerable number of articles on the topic of commodity prices and their apparent death spiral of late. Yes, deflation is something to worry about, but the experts will be the first to tell you that commodity price behavior is not always the best of economic indicators. Prices in this sector are driven by both supply and demand. Each driver can easily be manipulated, as well, and the often forgotten fact is that these prices are stated in U.S. dollars. As the chart below illustrates, the strengthening of the USD over the past 18 months has caused a degree of confusion.
On a currency-adjusted basis, the so-called crash in copper prices does not appear as foreboding as some would have us believe.
Are consumers upbeat as far as the near-term goes for 2015 and 2016?
While investor sentiment towards equities may have paled under the constant barrage of pessimism from the press, consumer confidence has actually risen quite nicely since the last recession. The Michigan Consumer Sentiment Index just keeps bouncing along:
Richard Curtin, chief economist for Surveys of Consumers, claims the latest positive leg up is due to two causes. Consumers are anticipating larger increases in their household income in the year ahead, together with lower inflation expectations – positive signs for increased spending going forward. Lower-income households were the most positive.
From an historical perspective, the current reading is nearly 8% above the arithmetic average of 85.3% for the index since its inception in 1978. Furthermore, “During non-recessionary years the average is 87.5. The average during the five recessions is 69.3. So the latest sentiment number puts us 23.8 points above the average recession mindset and 5.6 points above the non-recession average.” The overriding theme since 2008 has been one of gradual, but slow improvement.
Cyber-Criminals are determined to dim the brightness of the Holiday Season
There is one other disturbing trend that has been highlighted in recent articles that have hit the mainstream: “Online retailers braced for biggest cyber crime Christmas of all time!” Cyber-crime is on a rampage, and with Cyber-Monday just around the corner, the time is now to gird your loins. Change your passwords on sensitive financial accounts. Block pop-ups and ensure that your software protection tools are up to date. Be wary of any email communications that appear to be from account providers. They could be clever attempts from crooks to “phish” for your personal ID information.
In some regards, it may be too late. Hundreds of millions of accounts have been accessed by the criminal element in our society. You may already be an unwitting target. Law enforcement officials recently shut down what has been described as the largest cyber-crime ring in history. Since 2007, this network breached 100 million accounts from the likes of JP Morgan Chase (N:JPM), E-TRADE (O:ETFC), Scotttrade, TD Ameritrade (N:AMTD), Fidelity Investments, and News Corp (O:NWSA)'s Dow Jones unit, the publisher of The Wall Street Journal.
Court papers disclosed that, “The men charged—Joshua Samuel Aaron, Ziv Orenstein and Gery Shalon—are all from Israel… The charges involve many crimes, including running illegal internet casinos, handling the proceeds of other criminal activity, hacking into the computers of business rivals, and manipulating stock prices.” Be careful with online shopping – you can leave “digital footprints” for crooks to exploit.
Concluding Remarks
Investor sentiment may not be the highest at the moment for good reason. A quote from a recent report speaks volumes: “After someone goes through a traumatic experience they tend to be shocked into believing that the next big traumatic experience is right around the corner. But the reality is that outlier events are outlier events for a reason, they don't happen nearly as often as we expect.”
Will there be a Santa Claus rally? Based on previous statistics, the odds seem to favor this outcome. Will uncertainty and volatility drive the markets, as well? Most assuredly so, which means that there will be plenty of opportunity to profit over the coming days of good tidings. Be confident, be prepared, and trust your strategies! Happy Holidays!
Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.