Is that a Santa Claus Rally?

By: Mark McMillan | Wed, Jan 3, 2007
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Index Advisor 001
1/3/2007 6:59:00 AM

Holiday volumes shrank significantly with some of the lowest volume days of the year seen in the last week. We expect all that will change in the coming week as traders return from their holidays.

The last week saw a number of positive events. Energy prices fell significantly during the week. In fact, the stock market seemed to move opposite to energy prices during the week. Oil prices fell significantly on Tuesday and on Wednesday achieve a close below the $61 - $64 price range we have been monitoring. The close was at $60.34. Thursday and Friday saw new intraday lows with Friday's low recorded at $59.90 before dashing back up to close just above the $61 level.

Natural Gas had a similar effect on the stock market as it tested an important support level on Wednesday before bouncing from this level to close below $5.84. Thursday and Friday saw Natural Gas prices move higher, closing near $6.30 on Friday. The broader stock market moved opposite these price moves each day. This is why we have been intently watching the range of oil prices. We continue to believe that if oil moves outside of the range of $61 to $64, it will inversely affect the stock market.

It was a slow news week, but the news that was reported was pretty neutral or positive.

On Tuesday, the National Retail Federation (NRF) said it expects sales to rise 5% for November and December, as opposed to last year's 6.1% rise during the same period last year. They also expect an additional $6B in gift card sales this year, which nearly makes up for the lower rise in sales.

On Wednesday, new home sales were reported stronger than expected, with a seasonally adjusted annual rate of 1.047M new homes sold versus a consensus of only 1.015M, the bulls moved the markets higher. Even homebuilder stocks lifted on the news.

On Thursday, weekly Jobless claims were reported at 317K, 3K below expectations. Existing home sales were reported at an annual rate of 6.28M versus an expected 6.15M. Consumer confidence was reported at 109.0 versus an expected 102. This rose from 105.3 last month, which was revised upward from 102.9. Chicago PMI was reported at 52.4 versus an expected 50.2. Last month's 49.9 showed signs of economic contraction, while this month's report shows continued moderate expansion in manufacturing activity in the Midwest.

There were no economic reports on Friday, but Apple reported that it's CEO, Steve Jobs, didn't benefit from options that were backdated. They will take an $80M charge to cover expenses associated with those options. This was viewed as a positive as investors bid up the stock of Apple (NASDAQ:AAPL) which was largely responsible for allowing the NASDAQ-100 to eek out a positive showing, while the U.S. stock market, in general, sold off.

Finally, bond rates are moving higher, with a corresponding move lower for their prices. Initially, that is generally favorable for the stock market, as money will leave bonds and flow into equities, cash, or other investments.

Investors will be reviewing return to risk ratios and as interest rates on bonds rise, investors will be more attracted to them. Once they believe that interest rates are high enough, they will start buying bonds and the interest rates will stabilize. Money in equities will move into bonds and the stock market will sell off, and the risk of the stock market and returns from investments made in it will not be able to outweigh the long term safety and return of bonds.

Risk adjusted, as long as stock market earnings continue to grow at a faster rate than inflation and interest rates, then the stock market will attractive. The timing is when the risk of equities is considered high enough that the risk adjusted return is below that of bonds. We are a long way off from that occurring. But it is something to watch for over time.

The market rallied in the first two days of the week along with a significant drop in energy prices. The last two days of the week, the market sold off in conjunction with rising energy prices. For the week, the market is up but that move was on light volume, and came during a seasonally bullish period known as the Santa Claus rally. With the return of normal volumes in the coming week, the market will establish it initial direction for 2007.

A look at the chart for the Dow Industrials is represented by the Diamonds ETF (Amex:DIA).

Abbreviations and color key appears below:

Note the following order is Red, Yellow, Green, just like a stop light, so it might be a helpful mnemonic:
Thick Red line represents the 200-day simple Moving Average, (200DMA)
The yellow line represents the 50-day simple Moving Average, (50DMA)
The green line represents the 20-day simple Moving Average, (20DMA)
The light blue line represents the 3-day Moving Average, moved forward three days in time, (3x3MA)
The thick blue line indicates the exponential 13-day Moving Average (13DMA)
Bollinger Bands are abbreviated as BB. There is an upper and a lower Bollinger Band that varies in distance from a central moving average (shown as light red/pink) based on the volatility of stock price movements.
RSI stands for Relative Strength Index. It is an oscillator, which can be used to determine how overbought or oversold a stock may be.

The DIAmonds will likely want to close the window formed by the gap up open last Wednesday. That is around the $124 level. To get there, the DIAmonds won't have to violate any support lines or levels. With the DIAmonds in an unbroken uptrend and above all trend lines and support levels, you can't get too excited about downside action until some moving average or trend line is broken.

Note that the hourly chart of the DIAmonds shows a well-formed Harami. This generally indicates that the current trend will ease. In this case, the current trend was downward, so this indicates the DIAmonds descent may be over.

The S&P 500 ETF, known as the Spyders (AMEX:SPY) is shown in the chart below:

The chart for the SPYders is more interesting than that for the DIAmonds at this time. It shows a Harami pattern confirmed on Friday. Also, Friday's attempt to rally by the bulls was clearly defeated. A swing trade shorting the SPYders could be entered if the SPYders move to $141.40, although there is support at the $140.70 area. A failure to break through this support would indicate another test upward toward the $142.70 area.

The SPYders are very near the long term uptrend line and a significant breach of this line would likely be followed by a more significant move to the downside.

The Choppiness indicator shows that a new trend is readying to start.

This week's NASDAQ 100 ETF (QQQQ) Weekly Chart is below:

The QQQQs have put in an important candlestick pattern that indicates a braking of the downtrend, and perhaps a reversal to the upside. The Harami must be confirmed but suggests that the downtrend may be at an end at this time.

The choppiness indicator shows the uptrend was completed and the market is now consolidating. Markets can consolidate sideways or move up or down.

This week's NASDAQ 100 ETF (QQQQ) DailyChart is below:

The QQQQs are sitting below their 20-day and 50-day moving averages. They are also sitting below a short term downtrend line and well below their long term uptrend line. Friday's trading action suggests the bulls fumbled when trying to overcome resistance in the low $43.60s range. The bulls must overcome that resistance this week or the QQQQs downside action will really get underway.

The choppiness indicator shows a new trend has been strengthening, and that move has been to the downside.


The markets are historically bullish into the first couple of trading days of a new year. This is the period known as the Santa Claus rally. We have observed strange behavior over the years as new money is put to work causing strong rallies at the juncture of a new year. We wouldn't be at all surprised for this to repeat itself in the coming week.

The coming week could see the market move either way. The uptrend is long in the tooth, but there is reason to believe the soft landing scenario is intact.

Regards and Good Trading,



Mark McMillan

Author: Mark McMillan

Mark McMillan
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