The stock market showed an explosive reversal of fortune on Monday. For the first seven trading days following the U.S. presidential election, it had been a particularly brutal stretch for stocks with a cumulative decline of roughly -5%. But as stocks limped into the holiday shortened trading week, the market mood suddenly shifted to euphoria. On Monday alone, the stock market as measured by the S&P 500 rocketed higher by +2%.
Was the stock market surge induced by the gestures of optimism from Washington about a potential bipartisan agreement on the fiscal cliff? Perhaps, but these signals were already out on the street during the trading day on Friday, and the market reaction was positive but more subdued.
Was it instead the beginning of liquidity finally flowing through from the U.S. Federal Reserve’s QE3 stimulus program? This is also a possibility, particularly since the Fed’s balance sheet expanded by +$46 billion over the last week ended November 14, which marked the largest one week increase since early 2010.
Perhaps it was suggestions that U.S. capital spending may have bottomed and was poised to bounce higher with greater fiscal clarity in 2013? Maybe, but this idea should not have come as sudden news today to institutional investors that monitor the economy and markets on an ongoing basis.
The one thing we do know is what it was not. It was not signs of a sustained improvement in the economic outlook. It was also not because of the resolution of the ongoing crisis in Europe. Nor was it inspired by any sense of greater stability in the Middle East. Instead, today’s markets remain capricious and heavily influenced by the forces of fiscal and monetary policy that have distorted many asset classes beyond their normal behavior.
A few characteristics were particularly notable about today’s move higher in stocks.
First, stocks were able to reclaim at least for the moment support at the 200-day moving average on the S&P 500 Index. This is an important development from a technical perspective, for if stocks can continue to hold this critical support level in the coming days, it will reinforce the fact that the current uptrend in stocks remains in tact. With futures slightly positive heading into the overnight hours, stocks appear poised to hold their ground for the moment. And the fact that we are heading toward some of the lowest trading volume days of the year should also help, as the stock market has shown an uncanny knack since the aftermath of the financial crisis a few years back of exploding higher through critically important resistance levels on trading days when most investors are away on holiday.
Also, since the market first stabilized after the financial crisis in early 2009, whenever the stock market has posted a sharp and sudden rally of +2% or more following a sustained move lower in stocks, it has marked a definitive reversal and the beginning of a new sustained move higher in stocks. And with stocks soon entering the seasonally strongest month of the year in December along with a potential fiscal cliff deal around the corner and the flow of QE3 liquidity set to pick up from the Fed with each passing week, it would not be surprising to see such a rally begin to take shape once again this time around.
The fact that such a rally can occur despite a persistently weakening global economy and ongoing deterioration of the crisis in Europe highlights the degree of distortion in today’s markets. The stock rally certainly will not last forever, and watching positions closely as events unfold will remain as critically important as ever in the months ahead.
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