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The Case for Stock Market 2014 Year-End Rally

Stock-Markets / Stock Markets 2014 Nov 14, 2014 - 02:27 PM GMT

By: Money_Morning

Stock-Markets

Shah Gilani writes: U.S. stocks have been making new highs in recent days. And I believe we’re looking at strong odds for a market rally that lasts to the end of the year.

There are lots of reasons why stocks are headed higher, but one in particular is both surprising and telling.

It’s also a difference maker.


You see, if you understand what that “catalyst” is, you can pick some winners yourself.

And today we’re going to look at it together…

The Bonus Round

The financial markets – stocks, bonds, derivatives and currencies, for instance – can be quite complex.

But the catalyst that’s likely to drive U.S. stocks higher between now and New Year’s Day is surprisingly simple.

You see, if the players on Wall Street are going to earn their fat year-end bonuses – and, in some cases, actually keep their jobs – the Dow, the S&P 500 and the Nasdaq need a good rally during the final weeks of 2014.

Here’s why the institutional players are feeling such urgency.

In spite of markets making new highs repeatedly this year, it hasn’t been a smooth ride.

The bumps throughout the year, especially the mid-October swoon, kept money managers on edge and too often took them to the sidelines and out of the action. Worse, a lot of hedge funds were betting against the rising tide of stocks and shorting U.S. government bonds.

2014 started out well enough, but an ugly 5% dip in late January scared stock players into believing that the long-in-the-tooth rally was nearing a possible end.

That didn’t happen.

Stocks rallied back and higher, though not without a few minor bumps here and there.

Then at the end of July, after the S&P 500 poked its head above 2,000, we got another quick 5% pullback. Once again, there was talk of the rally getting tired and petering out.

That didn’t happen.

By late September, stocks made new highs, closing nicely above 2000. Then, seemingly out of nowhere in mid-October, stocks tanked about 8.75% in what seemed like the blink of an eye.

That’s when a lot of managers threw in the towel.

Most mutual fund managers sold winners and raised cash, while at the same time aggressive hedge funds shorted momentum stocks and tried to push the market lower.

Unfortunately, hedge funds got a double whammy in the mid-October selloff.

The mini U.S. stock market panic caused the usual “flight-to-quality” run into U.S. government bonds. The U.S. 10-year yield dropped from about 2.25% down to 1.85% with stunning speed.

The mini-panic had resulted from a sell-off in European stocks when weak European sovereign peripheral countries saw interest rates unexpectedly rise on their government bonds,

The problem for hedge funds was that they were short U.S. government bonds, believing that the coming end of quantitative easing would cause rates to rise. Bond prices fall when yields rise.

However, the flight-to-quality run into U.S. bonds caused bond prices to rise to near record highs – not fall. Hedge funds that were short government bonds got killed when prices went through the roof.

Then, even more quickly than it fell, the stock market bounced to new highs yet again. And just as quickly as bond prices rallied, they fell back to where they were before the stock-market sell-off.

Net, net, mutual fund managers and long-only money managers (“long-only” means they don’t short stocks) sold stocks, raised cash and went to the sidelines. Hedge funds had little choice but to lick their wounds and scratch their heads.

When the picture in Europe all of a sudden looked brighter, thanks to calming pronouncements from the European Central Bank, U.S. stocks rallied back with a vengeance.

However, because they feared the October sell-off was the end of the rally, long-only money managers missed the quick run-up to new highs.

Now, those managers are lagging the S&P 500′s positive 2014 performance, and hedge funds sitting on losses all have to figure out how to make money by New Year’s. Their bonuses and jobs depend on it.

Like Superman

So, the easiest path for them all is the path of least resistance, which is up, up and away. That’s what they’re betting on. They all got into stocks as the bounce was creating new highs, and now they have to push stocks higher so they don’t lose out.

That’s how Wall Street wants to play through year’s end. It doesn’t mean the market is guaranteed to go higher. There will be some big players who will short stocks up here and try and create a panic.

And the market is facing the usual macro-global headwinds. Russia is entering Ukraine again, and there’s the possibility of a full-blown conflict there.

Still, when it comes to Wall Street paychecks, they’re going to do whatever they can to get markets higher through the end of their December performance and bonus calculation period ends.

How can you play along?

The best opportunities will be getting into big-cap stocks that have lagged in the recent rally to new highs.

Players will look to push those stocks higher. Stocks having made new highs will be looked at as fully valued for the moment, and big-caps with good earnings that haven’t moved up as much will be seen as undervalued and ripe for a bounce.

Here’s why big-caps are the way to go.

After saving their jobs and earning their bonuses, managers may want to pull out after their year-end accounting periods have passed. And it’s easier to get out of more liquid big-caps than mid-caps and small-caps.

They look ripe to bounce, too, but are less liquid than big household names – so now’s the time to go large.

Source : http://www.wallstreetinsightsandindictments.com/2014/11/case-2014-year-end-rally/

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