An End-Of-Year Rally Is Likely. Here’s Why…
As many of you know, I’ve been expecting a pullback in the stock market.
Two weeks ago, I noted, “The chart indicates a 2.5% pullback is likely before we see the market rally sharply into the end of the year.”
The chart of the SPDR Dow Jones Industrial Average ETF (NYSE: DIA) is shown below with important support levels. On the bottom of the chart, I’ve tracked my Profit Amplifier Momentum (PAM) indicator. The pullback, from high to low over the past two weeks, was 2.9%.
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As you can see from the bars in the bottom segment, PAM is already showing signs of bottoming. That signal tells me that our pullback — while short — is likely already over.
Now, there could still be additional weakness in the first few days of the week, but it looks like we’re set up for an end-of-year rally. If you recall, I have given several reasons for this over the past few weeks.
One is that we are likely to see a shift in portfolio allocations from fund managers as we head into the new year — from bonds into stocks. As I said in this piece:
Because bonds have climbed so much over the past 12 months, they now likely account for a much larger proportion of holdings than when they started the year. That means, even if the outlook for bonds were bullish, professional fund managers would still have to dump a portion of their holdings.
Another reason, as I mentioned in this piece: Throughout history, most bull markets end in a blow off, which is a race to new highs with prices growing faster than the fundamentals. The blow off usually comes just as a recession is beginning. Right now, we are at the point where a blow off is likely.
The weekly chart shows that PAM has already turned bullish, with the bearish red bars subtly turning into bullish green bars around late November.
Despite the strong message we’re getting from the chart patterns, there’s still another bump in the road we need to get past.
I’m nervous because the Federal Reserve is meeting this week. On Wednesday, the meeting will conclude with an announcement about interest rate policy. This announcement will also include an update of the Fed’s economic projections. And the announcement will be followed by Chairman Jerome Powell’s press conference.
Futures prices indicate there is a 99.3% probability the Fed will not change interest rates at this meeting. Under Powell, the Fed has consistently followed the market, and I don’t expect that to change now. So I don’t expect to see a change in short-term rates. However, the Fed is active in the repo markets and is also buying bonds for its balance sheet. (I explained these two actions in detail in this piece.) Changes to these programs could be announced. The market is likely expecting small changes, if any. Large changes to bond buying programs could send stock prices lower.
The biggest risk this week is Chairman Powell’s press conference. The good news here is that Powell understands that risk as much as anyone. Based on his past cautiousness, he seems to be watching his words closely when he speaks. This should limit downside risks.
It is likely traders will hear Powell say that the Fed believes the economy is healthy and they will cut rates if data next year indicates cuts are needed. Key risks he is likely to cite include trade policy (which the president controls), the budget process (which Congress controls), and international economies (which the Fed lacks any ability to directly influence).
Action To Take
This is important because it shows stock market investors that the risks they face are hidden for now. There is no reason to be bearish other than the fact that the bull market is more than 10 years old.
Bull markets don’t die of old age. They die when recessions occur or global financial crises develop.
For now, we should remain bullish. The weekly chart of PAM is designed to minimize short-term trades, and the current signal is just four weeks old. Until weekly PAM weakens, I am preparing for a strong rally.
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