Monday, November 3, 2014

Short Sqeeze Rally

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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