After posting an impressive bull run after the election, the markets pulled back this week, prompting traders to wonder whether the run was over. Some analysts are arguing that the prospects of an interest rate hike are applying the brakes to this rally. I am more inclined to think we are looking at a simple case of profit taking.
If we back up a moment and look at the overall market for 2016, this has been a tough year for traders of all stripes to make money. SPX had only gained a little over two percent when we hit that low on November 4th. That isn’t a very pretty picture to present to your institutional clients. However, when the market hit that high on November 25th, the year to date gain was suddenly a much more respectable 8.6%. Maybe it’s time to lock in some gains. The large players were predictably nervous and ready to take profits the minute any softness appeared. The trading volume in SPX supports this viewpoint. The two strongest down days this week were Wednesday and Thursday, and trading volume spiked way above average both days. Anecdotal evidence comes from individual stocks. Some of the best recent stock runs abruptly ended this week for no apparent reason, e.g., NVDA, VMW, VEEV and others. Traders were locking in profits before they got away.
The prospects of lower corporate tax rates and a more business friendly administration has fueled this recent market run higher. But now the market is taking a bit of a breather. I think this is principally profit taking, so I don’t expect prices to trend lower from here. However, that doesn’t mean we can ignore the relatively weak economic data and modest levels of corporate profitability reported most recently. By most measures, this market is at least fully priced and may be nearing an overbought stage.
But we shouldn’t forget the calendar. The so-called Santa Claus rally during the last week of the year is thought to be triggered by large funds unloading losers for tax purposes. This may lower the prices of some attractive stocks that are quickly bought up, resulting in a short-lived rally. The Stock Traders Almanac has noted the historical pattern of small cap stocks outperforming the large caps in January and terms this the “January Effect”. This effect tends to begin around mid-December and lasts well into February.
Therefore, we are entering a time of the year that tends to be bullish, whatever the explanation. I will be watching the market on Monday to see if today’s modest gains signaled the continuation of a sideways to slightly bullish market. The strong run of late November couldn’t continue to the moon, but I don’t see any evidence of the bears taking charge of this market.