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Will Cliff Problems End Seasonal Rally So Soon?

 December 24, 2012 10:10 AM

The market has a consistent history of almost always experiencing a strong rally in the winter months, followed by a ‘Sell In May' tendency for that favorable period to end with a sell-off. Academic studies as well as our own in-depth research show that simply investing on that pattern, being fully invested in the winter months and exiting to cash for the unfavorable season, significantly out-performs the market over the long-term, while taking roughly only 50% of market risk.

The U.S. market seemed to have launched into that age-old pattern in November.

And it's not just a U.S. pattern, but a global pattern. Academic studies show the pattern has existed for many decades in 36 of 37 developed and emerging markets. Market's Seasonal Patterns in Global Markets!

And there has also been a rally underway globally with only a minor pullback in November.

However, no pattern or strategy is 100% perfect. And there have been a few instances when market corrections took place in the almost always positive favorable season.

The worst we have experienced was in the severe 2007-2009 bear market during the 2008 financial meltdown and crisis.

Even then the seasonal pattern avoided most of 2008 decline, significantly out-performing the market. And although there was another leg down in the fall of 2008, by May, 2009 the market had recovered most of that decline.

But obviously, although unusual, corrections can take place in the market's usual favorable season.

As the top chart shows, with this favorable season rally underway, markets have been confident until yesterday that the fiscal cliff talks would be successful in at least kicking that potential problem down the road into next summer.

And as I have been saying for a couple of months now (and as I did in 2011 in that fiasco leading up to raising the debt ceiling), it has been my expectation that an agreement would be reached but only in panicked meetings at the very last minute.

But as that very last minute approaches this time, only 7 days to go, it would be foolhardy not to realize that anything can happen when idealism may trump realism without regard for the consequences.

Our non-seasonal Market-Timing technical indicators remain on buy signals for a number of U.S. sectors and global markets, but the situation in Washington does have us watching them closely for any early signs of changes. 

Other Voices:

[Related -Bullish Sentiment Solidifies Even In The Face Of Lofty Valuations]

[Related -World Growth: Mediocre or Pathetic?]

Virtually no optimism:

Randall W. Forsyth, Barron's: "Politicians know the economy faces an end-of-the-world moment. Their solution. Let's go home for the holidays."

James Politi, The Financial Times: "Negotiations could take place quietly over the short-break, away from the bluster of Capitol Hill, to be followed late next week by votes that would garner both Republican and Democratic support. But pessimists warn that such a scenario is wishful thinking."

The Economist:"Any deal Mr. Obama and Mr. Boehner strike in coming days will almost certainly leave the details of tax and entitlement reform to 2013. By then, says Tom Gallagher, a policy analyst for the Scowcroft Group, the bipartisanship that made the initial deal possible may have petered out. The fiscal cliff will be gone; the fiscal uncertainty will continue."

Short-Term Market Patterns.

As we told subscribers last week, this week was the week of the December quarter's quadruple-witching options and futures expirations. The expirations week tends to be positive, and this week was positive, in spite of yesterday's 1% market decline.

The next pattern is that the week between Christmas and New Year's normally has a strong tendency to be positive. But the term normal is out of the picture for the moment as Washington keeps markets on edge with the cliff talks.



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