Tis the season for a stock market rally as year-end is rapidly approaching and with it the possibility of a Santa Claus rally for stocks.
But as I pointed out in a recent Money and Markets article, a year-end rally can be difficult to time. Plus, there are a number of red-flags flying right now that could signal an un-Happy New Year for investors. Let’s take a closer look.
First, as you can see in the graph below, December has indeed been one of the most wonderful times of the year … to be invested in stocks.
Based on the historical record since 1928, December is the second-best month for S&P 500 performance, up 75% of the time while posting an average gain of 1.4% for the month.
Using history as a guide, you can expect a bit of turbulence this week, perhaps carrying into next week’s pivotal Federal Reserve meeting Tuesday and Wednesday.
Make no mistake that the Fed could be a wild-card this holiday season.
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Fed funds futures now point to a 79% chance of a rate hike on Dec. 16, the first since 2006, so you can expect plenty of volatility both leading up to, and after, the Fed’s decision.
But if stocks continue to follow the historical trend, you can expect a year-end rally to start around mid-December. Here comes Santa Claus!
What worries me is that the stock market could face a
New Year’s hangover; here’s why …
In a previous article I pointed out that market breadth has been deteriorating in recent months. And, unfortunately, breadth has gone from bad to worse in recent weeks.
You can see above that the New York Stock Exchange Advance-Decline line has been stuck in a downtrend since May with no sign of a letup. This means fewer and fewer stocks are leading the market indexes higher, a troubling sign.
In fact, just a handful of stocks including Google, Amazon and Netflix are responsible for a big chunk of the gain in the S&P 500 since the August low. Even worse, just six stocks account for more than half the gain in the Nasdaq 100 Index since August. That’s simply not sustainable.
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Even more alarming, as I pointed out in my earlier article, credit stress is on the rise in financial markets. My colleague Mike Larson has done a great job of covering this story, so I won’t go into all the gory details. But the chart below gives you the whole sordid story in a single snapshot.
It shows the S&P 500 (top) and the Bloomberg U.S. Financial Conditions Index (bottom). As you can see, the financial climate has been deteriorating since mid-2014!
Notice the big spike lower in August. That coincided with a 1,000-point plunge in the Dow in just five days!
True, financial conditions did improve somewhat in September as the stock market rebounded, but the Financial Conditions Index is still locked in an unmistakable downtrend. Why?
Even while stocks rallied, bond market conditions got worse.
In fact, the SPDR Barclays High Yield Bond Index ETF (JNK) just plunged to multi-year lows this week, even while stocks are a stone’s throw away from setting new highs.
The last time junk bonds sold at such distressed levels was the fourth quarter of 2011, and the S&P 500 Index plunged nearly 20% at that time.
Bottom line: Something’s got to give. Even though seasonality points to higher stock prices in the weeks to come, several red flags keep warning of trouble ahead, perhaps in January.
In the meantime, keep a watchful eye on stock market internals (advancing vs. declining stocks, new highs vs. new lows, etc.) and credit markets (financial stress, junk bond spreads, etc.). If we don’t see an improvement soon, it could be an unhappy New Year for stocks.
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