Top Gun FP Client Note: After Euro-Phoria

As we close out a spectacular October, it’s a good time to take stock and consider the trading environment heading into year end.

 

In “The Case For A 4th Quarter Rally”, I listed three reasons to be bullish.  The first and most important was seasonal: the 4th quarter is historically the best for stocks.  The second was technical: 1100 represented solid support for the S&P.  The third was valuation but the better one was sentiment.  At that point in time, the market was quite bearish. 

 

I argued that if we could squeak through earnings season and the Europeans could patch something together, those three factors had a high probability of resulting in a strong year end rally.

 

Four weeks later, it is clear that everything went according to plan.  An oversold, overbearish market found technical support just below 1100.  Seasonal tail winds aided a dawning rally.  3rd quarter earnings exceeded lowered expectations.  Finally, the Europeans agreed on the broad outlines of a bailout package leading to a blowout move higher last Thursday.

 

At this point, the forces underpinning the case for a 4th quarter rally seem mostly spent.  Technically, we are no longer at the bottom of the range.  In fact, we broke out of the two-month range between 1100-1230 to new highs.  At these levels, there is a lot of congestion on the charts. We are right around the 200 DMA and just above the year’s breakeven point.  Indeed, it is only 100 points (8%) to the bull market highs of May.

 

Sentiment has reversed course along with the market with most now focusing on positive seasonality and the underperformance of mutual and hedge funds and their consequent need to catch up into year end.

 

Lastly, with 3rd quarter earnings winding down and the headline of the much anticipated European bailout, we have exhausted our two key catalysts.

 

While the market should hold up okay into year end as professional investors try to patch together a presentable year, significant additional upside seems unlikely.