Wednesday, January 8, 2014

Stock market outlook for 2014

Stocks sagged on Monday as the annual “Santa Claus rally” season came to an end last week.  As Stock Trader’s Almanac points out, “Santa Claus tends to come to Wall Street nearly every year, bringing a short, sweet respectable rally within the last five days of the year and the first two in January.”  Santa Claus did indeed appear on Wall Street this time around but was a bit stingy compared to the previous five years. 

This year’s Santa Claus rally began with the S&P 500 Index (SPX) at 1,828 and ended with the index at 1,831 for a miniscule 3 point gain.  While each year’s Santa Claus rally season since December 2008 has witnessed a net gain, this one was by far the smallest.  (The last seasonal loss occurred during the Santa Claus season of late 2007/early 2008, which of course heralded the credit crisis).

“Santa’s failure to show tends to precede bear markets,” writes STA, “or times stocks could be purchased later in the year at much lower prices.”  STA discovered this phenomenon in 1972. 

It’s probably worth mentioning that the last time a similar Santa Claus rally failed to result in a significant gain for the SPX was in the December 2006/January 2007 period.  At that time the Santa Claus rally delivered a net zero gain – the SPX opened the 7-day season at 1,418 and closed it at 1,418.  If there was any predictive value in this it was that 2007 would go on to be a turbulent year leading into the infamous credit crash of 2008.  It’s also worth noting that while the S&P did deliver a net gain for the year 2007, the gain was very small and the year itself could almost be classified as a net neutral, range-bound year for stocks as defined by the S&P 500 (the NASDAQ 100 and Dow 30 indices did much better than the SPX in 2007).

One must be careful of being overly dogmatic in assigning too much weight to the Santa Claus rally phenomenon, for as with every stock market seasonal tendency it can sometimes be misleading.  If there is any inference to be drawn from this year’s Santa Claus rally result, however, it’s that we should be prepared for the possibility that 2014 will be a much bumpier year for stocks with more downside potential during cyclical weak spots, as per our discussion in the 2014 Kress cycle forecast issue of the newsletter.

One reason for greater caution when trading equities in 2014 is provided by the economists at Kiplinger’s.  In the latest issue of The Kiplinger Letter they write: “Look for public corporations to pour less into share buybacks this year.  Though a disappointment to stockholders who reap the benefits of fewer shares…That’s good news for economic growth.”  The economists believe that Corporate America will begin spending more of its record piles of cash in expansion and hiring.  Kiplinger points out that “buybacks end up acting as a brake on growth rather than helping to fuel it.”  By the same token, a reduction of share buybacks will likely take momentum away from the equities bull market. 

Speaking of buybacks, Dr. Ed Yardeni featured an important chart in his latest commentary (  “Since the start of the bull market during Q1-2009 through Q3-2013,” he writes, “share buybacks totaled $1.6 trillion and dividends totaled $1.2 trillion, summing to a whopping $2.8 trillion!  Corporate cash flow rose to a new record high of $2.3 trillion (saar) during Q3.  Yet nonfinancial corporate net bond issuance totaled a record $665 billion over the past four quarters through Q3, with issuers using some of the proceeds to buy back their shares.

According to Barron’s, the ratio of insider transactions has reached a high level of selling as you can see in the following graph.  Corporate insiders are apparently expecting a bumpy ride in the not-too-distant future as they have increased sales of shares. 

 We haven’t yet reached a turning point in the market, however, as most major indices are still above their 15-day moving averages.  The NYSE short-term directional indicator, moreover, is still rising as of Jan. 6.  The market appears to be somewhat unsettled, however.  While the Dow and SPX remain above their 15-day MAs, the NASDAQ 100 Index (NDX) closed below its 15-day trend line recently, as did the Market Vectors Semiconductor ETF (SMH).  Thus we have a classic “split tape” in the making.  Caution is in order for now.