One reason is that investors abhor uncertainty. The Fed’s announcement this week that they plan in January to reduce their $85 billion/month bond purchases by $10 billion removed a major psychological barrier to the market’s advance. Investors now have a game plan on how and when the Fed will reduce their monetary stimulus and can adjust accordingly.
I commend the Fed and out-going Chairman Ben Bernanke. They handled what could have been a dicey situation adroitly. Bernanke, in his press conference after the FOMC meeting, managed to simultaneously reassure investors that interest rates would remain low, while focusing their attention on the growing strength of the economy. Since then the markets haven’t looked back.
So does this week’s event change my short-term attitude toward the stock market? I was expecting a decline in the averages. My first stop was the 50 day moving average. We hit that mark and bounced. Many of the indicators I watch are still pointing toward caution but others have turned positive again. I won’t fight the tape and will instead give the market the benefit of the doubt here.
Clearly, the Fed delivered the rally that Santa Claus couldn’t. I would expect the market to remain volatile but still maintain its upward trajectory into the New Year and possibly beyond. Given that I had recommended that investors stay long the market, despite any short-term declines, no harm was done. We can all enjoy the next few weeks of upside, but I do apologize for any undue stress I may have caused readers by predicting an imminent decline.
Wall Street winds down beginning next week through the beginning of January. It is a time when low volume allows smaller trades to have a larger impact on prices and we should expect increased volatility. Maybe we run up, maybe we come down, or maybe we just chop around, but without the big players the market behaves far less predictably. Once again, I advise clients to ignore any short-term moves.
I will mention that we are only weeks away from another stock market phenomenon called the “January effect.” At year end (actually starting on the last day of December) through the fifth trading day of January small cap stocks have tended to rise substantially. The effect is explained by the tendency of investors to first sell these stocks to create tax losses or raise cash for the holidays. This selling drives down prices far below their fundamental worth. Bargain hunters then move in and buy quickly driving up the prices and creating the January effect.
Unless you are an adept trader, I would not recommend you play this game; but for those who may hold some of these small cap stocks, it is good to be aware of these trends.
It’s been a good year for all of us, and well deserved. I want to take this opportunity to thank you for your support and wish all of my readers and clients a very happy holiday season.