Fund managers and investors alike are asking themselves whether the year-to-date highs for the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) are in the past or whether a Santa Claus rally could push us to marginal higher highs.
While market breadth is about as weak as I have ever seen it by some measures, a glimpse at seasonal patterns and an understanding of investor mood/psychology at this time of year can give us some hints about what the path of least resistance may look like into year-end and early 2016.
Year-to-date, the S&P 500 is just about flat, which is to say that the August/September weakness has now just about fully recovered itself. If flat is the new up, then investors have succeeded in saving the 2015 stock market … but really only the S&P 500 and a couple of other broader indices.
Market breadth as looked at through the lens of stocks trading above various standard moving averages or stocks trading at 52-week highs is plain awful. In other words, a big part of why indices like the S&P 500 or the Nasdaq are trading near their highs is due to their market-cap-weighted calculation.
If large-cap and thus more heavily weighted stocks like Amazon.com, Inc. (NASDAQ:AMZN) or Alphabet Inc (NASDAQ:GOOGL) rally, as they have this year, they can push these indices higher despite a large amount of other index component stocks trading lower.
This phenomenon is best exemplified by looking at the below chart where I plotted the SPY ETF against the ratio of the S&P 500 versus the equal-weighted S&P 500 in red. While the S&P 500 has been treading water year-to-date, the ratio of the two indices has fallen sharply since March. This tells us that, on a relative basis, the equal-weight index has badly lagged the normal S&P 500.
In other words, the majority of stocks in the S&P 500 are lagging behind on an equal-weight basis. While this is a concerning sign through a multi-month lens, it doesn’t mean that the entire stock market is going to fall apart immediately.
You see, the tendency for a Santa Claus rally and general market strength in the fourth quarter of any given year is well documented. But in order to fully respect this force we need to understand what causes it. A good part of this year-end strength in stocks has to do with performance anxiety on the part of under-performing fund managers, and this can be especially the case in a year where the broader indices have done little and market breadth has deteriorated big time.
Given that many fund managers are evaluated by performance in one way or another, many who are lagging their benchmark indices in Q4 are forced to buy stocks, and the stocks they chase higher are often the very ones that performed well all year. As for this year, large and heavily weighted tech stocks are the obvious targets, thus making the case that the indices could hold up and the S&P 500 could possibly push to new year-to-date highs before it’s all said and done.
Seasonally the S&P 50 and thus the SPY ETF tends to push higher through late-November and possibly early December. We then tend to see some mid-December weakness before the true Santa rally unfolds into year-end. On the below chart I plotted what this path could look like for the rest of the year.
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Successful trading and investing starts with a plan. Download Serge’s essential trading plan, TheEssence of Swing Trading e-book. As of this writing, he did not hold a position in any of the aforementioned securities.