Tuesday, January 4, 2011

Market Outlook

A number of bullish seasonals and other factors are coming into play across multiple time frames. The first two days of the trading year have strongly bullish seasonality, with the second day (Tuesday) stronger than the first (today).

Second, there is bullish bias for the first quarter of the year after mid-term elections in the presidential cycle, particularly in the months of January and March.

Third, the outperformance in the S&P 500 toward the end of 2010 suggests continuation. Fourth, after examination of the Fed’s statistics as of last Wednesday, Fed money printing is again making its way into circulation (as opposed to being deposited as excess reserves, as we noted two weeks ago).
Fifth, there is the so-called January effect, wherein stocks tend to post outsized returns in January.

Now for the bearish factors.
The January effect is greater for small cap stocks, and it is worth noting that the Russell 2000 index has been underperforming large caps recently.

To summarize, there is the beginning of distribution under the market’s hood, which is not showing up in the Dow 30 and S&P 500. Another bearish factor is excessively bullish sentiment, suggesting complacency.

Putting it all together, while strong short term bullish seasonality may give traders the confidence to bid the major indexes higher early this week, we would not be surprised to see a pullback develop by the end of the week. How deep or how long we cannot predict, but the long term picture looks solidly bullish, suggesting the next dip will be a good buying opportunity.

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