5 Reasons the Santa Claus Rally Won’t Last

The fix is in. And the Santa Claus rally looks like it can’t be stopped.

5 Overvalued Stocks to sellThe computer trading algorithms that dominate trading on Wall Street responded to the inclusion of the “considerable time” language in the Federal Reserve’s policy statement to post back-to-back 2%-plus gains on Wednesday and Thursday. (Nevermind all the nuance they missed.) We haven’t seen movement like that since March 2009.

Shares lost a little momentum on Friday, with the Dow Jones Industrial Average gaining 0.2% to finish with a 3% gain for the week. But rally mode was back on Monday, with the Dow up another 0.9%.

But some oddities are starting to pop up which suggest that, once we get past the holidays, the selling pressure that materialized in early December should make a reappearance. Here’s why.

#1 — The Fed


For one, the Fed is more hawkish than most realize, despite the excitement over the inclusion of the “considerable time” language.

During her press conference last week, Fed Chairman Janet Yellen warned that an April rate hike was still possible. She also focused on the transitory nature of the headwinds on inflation and implied that the tightening cycle could start with core inflation running near current levels — dismissing recent concerns about the drop in energy prices.

This hawkish outlook is reflected in the strength in the U.S. dollar, as shown above, which is helping to keep the pressure on crude oil.

#2 — Oil Prices


Next, it’s notable that energy prices are on the decline again after stabilizing, last week. A chaotic decline in crude oil was responsible for the selling pressure in early December as investors slowly evolved their thinking from “cheap energy is good for consumers” to “cheap energy is bad for energy companies” and started doing the math on the consequences.

Thus, high-yield bonds came under pressure as folks realized the extent to which high-cost shale oil producers have flooded the market with junk paper in recent years. And energy-exporting countries like Russia as well as those throughout Latin America have seen their markets and their currencies come under pressure.

Further weakness looks likely as OPEC reaffirms its commitment to holding prices down long enough to undermine much of the U.S. shale industry. Pair that commitment with a hawkish Fed, and oil may have to drop towards $40 per barrel to find a firm base of support.

#3 — Energy stocks


Lower energy prices have been dragging down the overall stock market via the energy sector as declines in stocks like Exxon Mobil (XOM) and Chevron (CVX) have been hard to ignore.

A bout of intense short covering last week managed to help the sector rally for four days straight. But the sellers are back out on Monday, threatening a resumption of the downtrend that started back in June.

#4 — Fear


Although the Dow is just 100 points from a new record high as I write this, the options market seems to think things are more vulnerable than they appear. You can see this skepticism in the way the CBOE Volatility Index (VIX), known as Wall Street’s “fear gauge,” is a third above the lows set in early December.

This divergence is driven by higher put option contract pricing, reflective of increased demand for downside protection against a market downturn.

Put more simply: Options traders don’t think we’re out of the woods just yet.

#5 — Technicals


While the large-cap indices flirt with record highs, broad measures of the stock market suggest the bulls are still constrained by technical resistance that has been in place since the Independence Day holiday. You can see this in the chart above of the NYSE Composite (NYA), which is contending with triple-top resistance near 11,000.

Besides price, breadth has been disappointing with just 73% of S&P 500 stocks in uptrends vs. 76% in early December and 85% back in July. As I write this on Monday afternoon, there are only 212 net advancing issues on the NYSE, down from a high of 2,500 last Wednesday.

So, what is an investor to do about all of these worrisome signals?

Stay Defensive


I continue to recommend that my subscribers remain cautious with a large cash allocation as end-of-year window dressing and other odd market behavior mask what are deeper, underlying problems that should rematerialize in early January.

After bagging big gains during the mid-December weakness, including a 518% rise in the December $28 Short-Term VIX (VXX) calls and a 278% gain in the December $15.50 puts against Alcoa (AA) for Edge Pro subscribers, we’re holding fast for now as one of the most aggressive and dramatic short-covering rebounds in market history runs its course.

Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters.

Article printed from InvestorPlace Media, https://investorplace.com/2014/12/santa-claus-rally-wont-last/.

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