The Santa Claus Rally Begins?

After losing a painful 4% the prior week, the S&P500 bounced back—actually roared back—with a 4.8% gain last week. Unfortunately, volume only inched higher; this implies that investors are not totally enthusiastic about the big price gain. And volatility, while it did drop down as expected, did not fall anywhere near the lows of the summer. The VIX index closed on Friday at a still somewhat elevated level of 18.07.

There were plenty of US economic reports last week, but none of these appeared to drive the US equity markets higher. Among the misses were the Dallas Fed manufacturing survey, the Case Shiller home price index, new home sales, the Richmond Fed manufacturing index, international trade in goods, initial jobless claims, and pending home sales. Among the positive surprises were the Chicago Fed national activity index, wholesale inventories, personal income and personal spending, as well as the Chicago PMI result. In other words, there was no huge change in trend with respect to the US economy, which continues to muddle along, with the recent tailwind from the Trump tax stimulus about to dissipate.

Technically, the S&P returned to its 200 day moving average. This is critical in terms of repairing the technical damage incurred since early October. For the bull case to grow stronger, now the S&P must rise above the 200 day and remain there. After that, the S&P’s next bullish target will be the 50 day moving average. A critical data point supporting the bullish case is the fact that the S&P’s lows, at each major sell-off during the year, have been higher than the preceding lows. A series of higher lows make the bearish argument difficult to accept, at least for now.

What drove the markets higher last week was political news and the expectation of a reprieve between the US and China in terms of their trade dispute. If the US does not go forward with slapping tariffs on virtually all of China’s imports into the US, the US equity markets should rally even further.

This sets up a positive scenario for risk assets heading into the close of 2018, when many market watchers were already expecting a favorable seasonal set up (the “Santa Claus Rally”) to push equity markets higher. If the US-China trade dispute continues to abate….at least for a short while….then the odds of this Santa Claus rally continuing for the next two to three weeks should increase dramatically.

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