Market Outlook
The Bank of Japan drove Friday’s price surge by surprising
investors with an announcement that it would increase its bond and asset
purchases. "The Japanese central bank has taken the Quantitative Easing (QE)
baton from the Fed, and equity traders couldn't be happier," said David
Madden, market analyst at IG. Investors were also motivated by speculation that
the European Central Bank will follow Japan lead by announcing stepped up
stimulus measures at their next policy meeting this upcoming Thursday. This appears
to be a classic ‘short squeeze’ as money managers had been mostly sitting on
cash the past few weeks and were under-invested. As stocks moved higher last
week investors needing to get back into the game bid prices up. Institutional
investors who had to deal with end-of-month window dressing needed to get fully
invested as the month ended which further exacerbated the short squeeze.
Both the Dow and the S&P 500 closed at all-time highs as
the month ended. All told, U.S. stocks ended October solidly higher, up 2.3
percent. Strong U.S. corporate earnings were the primary driver of the rebound
as well as signs that central banks in Japan and Europe were going to do all
they could to stop their economies from dragging everyone else down with them.
U.S. companies have been reporting strong quarterly results the last two weeks.
Corporate profits are up 7.3 percent from a year ago, according to FactSet,
compared with the 4.5 percent investors had expected at the beginning of the
month.
Recent analysis played out exactly as advertised “…. It is reasonable to expect the next few
weeks will probably be similar to early April and July when price pullbacks
were a prelude to a pickup in quarterly earnings announcements where investors
bid stock prices back up… If this trend continues and the Federal Reserve doesn't offer a surprise at their FMOC meeting this week stocks can be expected
to continue climbing back toward recent highs…” In the updated performance
chart below most of the major equity indexes are showing their highest
percentage return for the year. The Russell 2000 is the only laggard as the
index has just gotten back to breakeven year-to-date. The small cap index needs
to go positive for the year for stocks to maintain bullish momentum.
Investor Analysis
According to the Stock Trader’s Almanac November maintains
its status among the top performing months as fourth-quarter cash inflows from
institutions drive November to lead the best consecutive three-month span
November-January. November begins the ‘Best Six Months’ for the DJIA and
S&P 500, and the ‘Best Eight Months’ for NASDAQ. Small caps come into favor
during November, but don’t really take off until the last two weeks of the
year. November is the number-three DJIA and S&P 500 month since 1950. Since
1971, November ranks third for NASDAQ. November is second best for Russell 1000
and Russell 2000 third best since 1979. In midterm years, November’s
market prowess is relatively unchanged. DJIA has advanced in 12 of the last 16
midterm years since 1950 with an average gain of 2.5%. S&P 500 has also
been up in 12 of the past 16 midterm years, gaining on average 2.7%. Small-caps
perform well with Russell 2000 climbing in 6 of the past 8 midterm years,
averaging 3.9%. The only real blemish in the November midterm-year record is
1974 (DJIA –7.0%, bear market ended in December).
Surprisingly, the rebound in stock prices at the end of
October has been driven by the defensive sectors. As seen in the updated graph
below, the utility sector has been the best performer, notching up gains of approximately
7% for the month of October. Historically, investors have purchased
utilities shares for their robust dividends as protection against stock price
drops. Generally, you would expect the demand for utility shares to decline
when sentiment is strong, but this has not been the case. Utilities held up
better than every other sector during the recent correction and we said they
would be a leader when stocks recovered. The question for investors is: Can
utilities continue to lead the broader markets higher in the last two months of
2014? Healthcare and Industrials are the other sectors to consider as the
market heads higher. Going long the S&P 500 index near the
end of October and holding until just before Christmas has been successful 24
of the last 32 years, or 75.0% of the time.
By Gregory Clay
Investment Strategist
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