December 2018: The end of the year (and may be the first three weeks of January) rally is coming
From a fundamental point of view, we should have expected a gentle end of the year rally as the headwinds of the market had been addressed and positioning was at its 5-year low. Indeed, Powell had given up on its hawkish communication. The truce in trade wars should have gotten rid of the major overhang for the markets. Last but not least, OPEC delivered a better than expected production cut which should have stabilized oil market.
But this proved to be a false signal as a Fed misled communication triggered extreme selling.
After the sell-off whose climax was on December 24th and 26th, we have more obvious clues that a more sustained rebound is in the cards:
– In the last month, outflows from both stock and bond funds exceeded more than 0.2% of assets on average each week, a 15-year record for both markets. Both markets rallied after other large outflows from investors.
– There are contrarian bullish sentiment signals with a significative breadth thrust to support the rebound (every time stocks rebounded since October, there were no massive participation and eagerness among buyers, while within the past 10 days, there have been two the best thrusts we’ve seen in 60 years).
– A contrarian positive development can be found in capitulation hints. $46 billion outflows from equity funds in the last week of December is the largest outflow in at least 15 years. Then, pessimism among retail investors jumped to its highest level in 6 years, according to the latest American Association of Individual Investors survey.
– Last but not least, indexes are on their supports. The S&P500 is spot on the low band of its 2575-2850 range since October and could easily rebound 150 points for the next month. It’s extremely rare for stocks to suffer this badly in December, and every time it has, stocks bounced into January. The chart below gives also a few positive hints: (1) we are in the green zone from which the S&P500 rebounded every-time this year, (2) we had at least one extreme selling pressure as shown by the extreme TRIN above 3 , (3) there is a big bullish divergence on RSI since October and (4) nobody has remarked that us rates are going north again.