Articles

By: Costas Bocelli — December 13, 2018

Where is the Santa Claus Rally?

CostasAccording to the Stock Trader’s Almanac, the strongest part of the investing calendar occurs during the months November through April.

Well "Bah, humbug!" to that…

…because ever since the calendar flipped to November, investors have seen one bumpy sleigh ride.

Sure, the stock market corrected in October.  But only after the major market averages posted their strongest quarterly gains in five years.

Nothing unusual there.  A corrective action within a bull market is normal, even necessary, as it restores balance.  In other words, market conditions became excessively overbought and investors too complacent.

But after the selloff, things were supposed to turn bullish again, especially as the holidays approached.

Well, not so fast…

After a brief rally following the midterm elections in early November, stocks suffered their worst Thanksgiving week since 2011, as stocks retested the October correction lows.

Stocks got another boost during the late-November G-20 meeting after the U.S. and China forged a 90-day truce in their trade dispute.  But that rally quickly fizzled, and stocks got off to their worst December start since 2008.  Again, they retested the October lows.

This brief summary paints a bleak picture, I know.  But don’t despair...

Because the market landscape is in fact ripe for a Santa Claus rally, one that could reinvigorate the bulls and re-start Mr. Market’s jolly ole heart.

Three Reasons Stocks Are Poised For a Strong Rally

First, there's the technical set-up in the major stock market averages.  In a correction, the market typically “shakes out” as many investors as possible before ultimately resuming its longer-term bullish trend.  And that means increased volatility and erratic swings.

Have a look at the daily chart on the S&P 500 index.

(Click any image to enlarge)

SPX

As you can see, the trading bands have widened and the market lows have been tested, retested and even broken on an intraday basis.

The trading action on Monday, December 10th screams "market reversal".  The S&P 500 traded down intraday to 2,583, before rallying to close the day at 2,638, a gain of five points.

Monday produced a simple candlestick pattern called a “hammer bottom”.  The pattern, when it emerges, is considered a bullish reversal pattern.

This pattern -- which resembles a hammer -- features a long lower tail (or wick, the intraday low).  The subsequent intraday rally creates a “body” near the day's high.  This all happens on a day at or near a meaningful low on the trend chart.

We saw two hammer bottoms emerge during the winter correction in early-2018.  You can see how powerful they are as a signal, by noticing the way they precisely bookended the correction.

The hammer bottom on February 9th marked the first wave of the selloff in the correction, which actually turned out to be “the low”.  And after several failed rallies and retests, the correction ultimately resolved itself in early-May,  culminating in the “hammer bottom” made on May 3rd.

In my two-plus-decades as a professional trader and investor, I've seen how a “hammer bottom” can be a reliable “tell” that a bullish reversal is at hand.

So the Holiday message may be that theDecember 10th indeed marked the correction low.

The second reason stocks could be poised to rally is that investor sentiment has recently turned bearish.  This is important, because sentiment is typically a contrarian indicator.

When investors are too bullish, it’s usually a good time to turn more cautious, like in late-September, when retail investors and professional newsletter advisors al became too bullish.

According to the AAII sentiment survey, 46% of retail investors were bullish and only 25% were bearish.  And according to the IIAS survey that polls professionals, 62% were bullish and only 21% were bearish.

Now the tables have turned…

Over the past several weeks, we’ve seen a spike in bearish sentiment and a decline in bullish sentiment.  Heading into the holiday season, only 25% of retail investors were bullish and nearly half were bearish.

As for “the pros”, bullish sentiment recently dropped to 38%, the lowest reading in 2018!  When sentiment reaches such a bearish extreme, it’s usually a good time to gain bullish exposure.

The third and final reason stocks might be headed upward is that the “true market”, or the breadth of the market has become excessively “oversold”.

Much like sentiment, when the breadth indicators get stretched to an extreme, the odds of a reversal in the external markets increases dramatically.

One of the internal breadth indicators that we watch intently is the NYSE %30 WEEK MA.

NYSE thirty week

This indicator basically tracks the percentage of stocks within the NYSE Composite that are trading above their respective 30-Week moving average (150-Days).

When fewer than 30% of the stocks are trading above the 30-Week MA, the breadth indicator is considered to be oversold.  But when it declines below 20% (like it is right now), it’s considered extremely oversold.  Readings at these levels are very rare.

The last time this indicator was below 20%, it coincided with a meaningful low,  presented a gigantic opportunity to buy and accumulate stocks, as was the case in early-2016.

Heading into the end of this year, we find the indicator in a similar deeply oversold condition, making the risk-versus-reward calculation very attractive.

Let's look deeper...

The Technology Sector has been one of the hardest hit sectors during the recent correction.  Yet within this group you’ll find many stocks that delivered the biggest and strongest gains over the past couple of years.

Hard-hit or not, investors should not lose sight of the fact the Technology Sector remains the highest ranked broad sector among U.S. Equities with respect to long-term relative strength.

With the recent weakness in the stock market, investors could look to gain bullish exposure to individual technology securities that continue to maintain a long-term positive trend and possess strong qualities of relative strength.

Here are four technology stocks that fit the bill:  Adobe Systems (ADBE), VeriSign (VRSN), Intuit (INTU) and Cree (CREE).

Until next time!

Costas

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