Investor Alerts

29 November 2012

December 2012 Trading & Investment Strategy


December 2012 Trading & Investment Strategy


November 29,


December Almanac Investor Seasonalities (Stock Trader's Almanac Pages 92, 94 and 96)

Dow: 52.4% S&P: 66.7% NAS: 66.7% R1K: 66.7% R2K: 66.7%

"The stock market is that creation of man which humbles him the most."

 Market at a GlanceBy Christopher Mistal

Market at a Glance

11/28/2012: Dow 12985.11 | S&P 1409.93 | NASDAQ 2991.78 | Russell 2K 813.50 | NYSE 8207.36 | Value Line Arith 3047.02

Psychological: Apparently Festive. Curiously, according to the Conference Board Consumer Confidence survey, consumers are feeling the best they have in four years. Apparently, looming tax increases and spending cuts along with the anticipated dire economic effects are not going to stand in the way of this year’s holiday activities. I guess next year is still quite distant in many people’s minds. Unfortunately, next year is only a little over four weeks away and the expiration of the payroll tax holiday will be felt immediately in the New Year when the first pay checks are handed out.

Fundamental: Soft. Revised third quarter U.S. GDP climbing to 2.7% is encouraging, but come on, 2.7% is nothing to get too excited about. Bottom line is growth remains sluggish and insufficient for any quick and significant improvement to occur in the housing or labor market or to boost corporate earnings. Should the fiscal cliff hit, the U.S. could find itself in another recession along side the Eurozone. Even if the cliff is avoided (to some degree), Europe’s woes are still likely to weigh heavily as they are an important trade partner.

Technical: Running into resistance. After breaking through support at their respective 50- and 200-day moving averages at various times over the last two months, the major indices recent rally has stalled at these previous support levels. DJIA is still struggling with its 200-day moving average, but S&P 500 and NASDAQ are running into their 50-day moving averages. Relative strength and stochastic indicators have rebounded sharply, but are nearing overbought levels which could further weigh on the market.

Monetary: 0-0.25%. The song remains the same. Easy money has been available to those that are qualified since 2008 and is likely to remain so for the foreseeable future, but those that are qualified probably don’t need it anyway. Operation Twist is currently expected to be completed this month, at which time, the Fed could remain active in the Treasury market with additional outright purchases. Should D.C. drive over the fiscal cliff, it will probably be up to the Fed to clean up any ensuing mess.

Seasonal: Bullish. December is the number one S&P 500 month and the second best month on the Dow Jones Industrials since 1950, averaging gains of 1.7% on each index. It’s also the top Russell 2000 month and second best for Russell 1000 and NASDAQ. However, election-year forces do temper December’s results. The “January Effect” of small-cap outperformance starts early in mid-December. Wall Street’s only “Free Lunch” of distressed small- and micro-cap stocks making new 52-week lows on December Triple-Witching Friday will be served before the opening bell on December 24. Santa’s Rally begins on Friday December 21 and lasts until the second trading day of the New Year. S&P has averaged gains of 1.6% since 1969. In years when Santa Claus did not come to Wall Street, bear markets or sizable corrections have often materialized in the coming year, particularly when the market was in a secular bear as it is now.

 You Better Watch Out! If Santa Claus Does Not Come to Wall Street Stocks May Slide In 2013By Jeffrey A. Hirsch

Jolly old Saint Nick’s factors and exchequers will be checking their lists more than twice this December. The folks on Wall Street and in corporate boardrooms have been on double secret probation for three years now, but if the residents of the White House and Congress continue to be naughty and don’t play nice and work out a deal to prevent the U.S. Federal Government from pulling a Thelma and Louise over the fiscal cliff, the Santa Claus Rally may be in jeopardy – and that could be an ominous portent for the stock market in 2013.

But before we examine the history, let’s first clarify what the Santa Claus Rally (SCR) really is. It is not any yearend rally as so many mistakenly represent and believe. Discovered in 1972 by our illustrious Editor-at-Large and creator of the Stock Trader’s Almanac (page 112), Yale Hirsch, it is the brief yet decent and consistent rally that occurs nearly every year during the last five trading days of December through the first two trading days of January. The SCR has been good for a 1.5% gain on the S&P 500 since 1953.

However, the real importance of this SCR is not as a massively profitable trading vehicle, but as the first indicator for the market in the New Year. Years when the Santa Claus Rally (SCR) has failed to materialize are often flat or down. In the 60 years since 1953 SCR has not emerged 13 times. Seven of these 13 losses were followed by flat or down markets. The last four times SCR has not occurred were followed by two flat years (1994 and 2004) and two nasty bear markets in 2000 and 2008. As Yale Hirsch’s now famous line states, “If Santa Claus should fail to call, bears may come to Broad and Wall.” 

Santa Claus Rally Table

Small Cap Free Lunch

As the market is currently exhibiting rather typical end-of-November strength, despite fiscal cliff bickering, the usual weakness in early December is likely. With the averages pushing on recent highs once again, the tax-loss selling that creates this weakness can be expected as well as the selling from institutions attempting to lock-in gains for the year. This behavior is what sets the stage for the aforementioned Santa Claus Rally. It also contributes to the January Effect and our Free Lunch bargain stock strategy.

For years there has been this January Effect of small cap stocks outperforming large caps in January. This is not to be confused with our January Barometer, which is an indicator for the rest of the year, to wit: as the S&P 500 goes in January, so goes the year. The January Barometer has only seven major errors since 1950 for an 88.7% accuracy ratio, including the eight flat years (less than +/- 5% for the year) yields a 75.8% accuracy ration. However, in recent years the January Effect now begins in mid-December.

Our annual Free Lunch strategy takes advantage of these seasonal tendencies of late-December gains. Each year we provide a basket of bargain stocks selected from stocks making new 52-week lows on the third Friday of December – AKA Triple Witching, stock option, index options and index futures all expire together every quarter. We cull down the list over the weekend, removing any splits, new issues, funds, and any suspect shares. We sell any quick gains and often get out quickly in January if the gains begin to fade. Our Free Lunch stocks have been down only 8 times in the last 38 years and beaten the NYSE composite in all but 5 of those years, for an average gain of 12.7% that beat the NYSE by 9.5% on average.

Cliff Hanging & 2013 Forecast Preview

As we discussed on the blog yesterday, going over the fiscal may not be so horrible. It may be the easiest political solution. It could cause the market to drop 10-15%, but that could be the impetus to force our grandstanding politicians to the table to compromise and find a solution. Both parties can save face by cutting back on the fiscal cliff tax increase and giving back some of the spending cuts.

Whatever the outcome of this fiscal cliff standoff, markets are likely to come under pressure in 2013 as the president and congress duke it out over how to remedy the sluggish economy, generate job growth, reduce the deficit and reconcile differences on entitlement programs and the tax code. Year-over-year and sequential economic and corporate comparisons will become more difficult in 2013.

Recession and debt woes in Europe are likely to continue to weigh on markets as will slower growth in China, Japan and elsewhere. Diplomatic and military tensions in the Mideast and surrounding vicinity are likely to pressure markets as well. On the positive side the Bernanke Fed will continue to back stop the economy and market, but now that the campaigning is over, after any yearend rally in 2012 and Q1 strength the path of least resistance for the stock market is likely lower in 2013.

Pulse Of The Market

After hovering between its 50- and 200-day moving averages (1) for nine trading sessions, DJIA broke down the day after Election Day. DJIA’s 200-day moving average was a key level that had provided some support, but once it was violated and DJIA closed below it, it is now behaving like resistance. And if DJIA can reclaim and hold this level, the next area of resistance would be the 50-day moving average, which is currently at 13,200 and falling.

DJIA’s faster moving MACD Buy indicator turned positive on November 6th alongside S&P 500 and NASDAQ MACD Buy indicators and our Seasonal MACD Buy Signal was issued. This signal proved fleeting as post-election blues slammed the market the next day, turning MACD negative again. Both the faster and slower moving MACD indicators remained negative until November 20th and 21st respectively when they turned positive (2). This second signal was dismissed as geopolitical and fiscal cliff concerns still dominate and are likely to create a choppy trading environment through yearend. 

Dow MACD Chart

Following four straight weeks of declines, DJIA enjoyed its best weekly gain of 3.4% (3) since advancing 3.6% in the first full week of June trading. S&P 500 (4) and NASDAQ (5) also had their best weeks since June. This solid performance was the best Thanksgiving week since 2008. Gains were massive then: DJIA +9.7%, S&P 500 +12.0%, and NASDAQ +10.9%, but then the previous three weeks had erased nearly 15% from DJIA. This year’s brisk Thanksgiving week reversal may or may not mark the end of the market’s pullback. It certainly was not the end in 2008.

The number of Weekly NYSE Decliners (6) peaked in mid-November at their highest level since June. In the same week, new 52-Week Lows (7) also reached their highest number since the week ending October 7, 2011. Past spikes of this magnitude were frequently followed by a strong rally which is exactly what ensued in the following week, but one positive, holiday-shortened trading week does not confirm the pullback has run its course.

Weekly CBOE Put/Call ratio (8) reached its highest level since mid-June last week at 0.77 which roughly correlates with the last time market volatility, measured by VIX, spiked and the market traded at the lows of the year back in June. The ratio has since returned to the exactly neutral level of 0.60, the market could go either way from here. 

Pulse of the Market