One of the best-known seasonal stock market phenomenons is the Santa Claus rally. Mark Hulbert of Marketwatch wrote in 2009: “Even though lots of advisers refer to something called a Santa Claus Rally, there is little agreement on what, exactly, it involves.”  Some analysts believe it only occurs the final week of the calendar year. Others think it refers to the entire month of December. Some believe the holiday rise in stock prices is a myth, much like the man it is named after.

If the Santa Claus rally exists, this year it seems to coincide with the appearance of Christmas decorations in the big box stores.

Back on September 16, I wrote that the technical indicators were hinting that stocks were perhaps nearing a turnaround. Then there was another downturn that seemed to quell any hope of a substantial rally. Yet October has provided the strongest advance so far in 2011.

The chart below illustrates what has occurred. I used the New York Stock Exchange Composite (NYA) for this illustration because this advance has been a broad-based move. Charts of all major indices look very similar.

On the Oct. 7 update, I wrote that major indices were approaching their 50-day moving averages (MA) and that they would have to break through that resistance and trend above a 50-day MA if the rally were to be sustainable. That has come to fruition as is clearly visible from the MA (gold line) on the top portion of the chart.

The middle section of the chart shows a moving average convergence divergence (MACD). This indicator has moved into positive levels and is not yet signaling that it is overbought. However, the rise has been quite steep. As a result, it would not be surprising to see this move level off. The NYA is up about 18% since the start of the month and that type of momentum is usually not sustainable for a prolonged time.

The bottom section of the chart is a stochastic oscillator. It has reached an overbought level, but during a strong uptrend, this indicator can stay at an extended level for some time. In the first three months of 2011, it remained in an overbought area as stocks continued to trend upward.

Whether or not this move counts as a Santa Claus rally, there are other seasonal reasons why stocks are likely to hold onto some of these gains if not add to them by the end of the year. With just two months remaining in 2011, the entire financial industry would love to end the year in the black. In addition, everyone in Washington D.C. would also like to end the year with some positive economic news. After this latest rally, most major indices are sitting at about break even for the year. These groups are all going to do whatever is in their power to keep stocks moving up for the next two months.

No one can dispute that the economy still faces significant challenges. Many potential problems could occur that would derail this recent move. But we have learned that the best course of action is usually to trust what the technical indicators are showing. And right now those indicators are pointing to higher market levels over the next few weeks.

Flint Stephens

Unlike some other GOP presidential candidates, Herman Cain believes the Federal Reserve can be saved. But he does not like the Fed’s most recent “Operation Twist” or Quantitative Easing programs.

“I don’t agree with it. We need to get back to sound money. Every time the Federal Reserve comes up with one of these twists—no pun intended—they are just masking the failures of not having an effective economic policy,” Cain said.

I had an exclusive one-on-one interview with the GOP presidential frontrunner Tuesday evening after the presidential debates in Las Vegas. Even at the end of a long day, he answered my questions thoughtfully and patiently. He was articulate and obviously has a thorough understanding of the nation’s current economic troubles.

A former chairman of the Federal Reserve Bank of Kansas City, Cain was one of the wizards behind the curtain when it came to the data used to diagnose the health of the U.S. economy. In addition to his business background, Cain has academic training that helps him understand numbers. He earned a bachelor’s degree in mathematics, and a minor in physics, from Morehouse College in 1967. He also has a master’s degree in computer science from Purdue University.

Asked about whether the American people can trust any of the figures that come from Washington D.C., he said, “It depends on which agency the numbers are coming from, to be perfectly honest.” Cain said he trusts numbers that come from the Federal Reserve, but he doesn’t agree with all of the agency’s actions.

He said the Fed faces a difficult challenge right now. “The Fed has two objectives in its mission when it should really only have one,” he said. “It is supposed to control unemployment and inflation by varying the money supply. That’s two targets with one arrow. Congress needs to clip its wings and say, ‘Just focus on price stability — keeping inflation in check.’”

Cain said having sound money is important to the overall condition of the U.S. economy and currently the value of the U.S. dollar is hindered by an enormous debt burden and a lack of economic growth.

“You wouldn’t want to wake up in the morning and read on the front page of the newspaper that an hour has been cut back to 58 minutes,” Cain said. “Just like the measurement of time must be solid, the measurement of weights must be solid, the measurement of money must be solid. And that means we get the Federal Reserve back to one thing and that is controlling inflation.”

Cain said that merely cutting government spending is not an effective way to deal with the debt burden. “I have an approach to how we are going to cut things, but the other thing is you’ve got to grow this economy. This is why the Federal Reserve has been doing all these creative things to try and be a backstop to the Treasury.”

Cain said when he served on the Federal Reserve in the 1990s, the Fed was able to control inflation because GDP growth was good and members did not have to concern themselves with a $14 trillion deficit.

“In the 1990s, more foreign countries were standing in line to buy our debt. With $14 trillion and a downgrade in our currency — in our rating — not as many foreign countries are standing in line as often,” he said. “We’ve got to get our house in order by growing the economy and bringing down the national debt.”

Alan Greenspan was chairman of the Federal Reserve during Cain’s time with that agency. He noted that while many people are critical of how Greenspan managed the Fed, he believes that during that period it accomplished its mission of keeping inflation under control.

It was his questioning of numbers that first gained Cain attention in the political arena. In 1993, he was president-elect of the National Restaurant Association when he challenged President Bill Clinton over costs imbedded in a proposed health care plan.

When Clinton defended his plan, Cain is reported to have responded: “Quite honestly, your calculation is inaccurate. In the competitive marketplace it simply doesn’t work that way.”
Flint Stephens

Special Note: I wanted to let you know that next week I will attend the GOP Presidential Debates in Las Vegas. Afterward, I have a personal interview with Herman Cain, currently one of the top candidates for the Republican nomination. For those who might not be aware, Cain was chairman of the Federal Reserve Bank of Kansas for much of the 1990s.  In addition to questioning him about his 9-9-9 economic plan, I plan to ask his opinion about recent actions of the Federal Reserve, including the “twist” plan currently underway. I’ll report on his comments in next week’s commentary.

After many weeks trapped in a sideways pattern, major stock indices are on the verge of breaking above resistance and beginning a new intermediate-term rally. The only question is whether there is enough strength and momentum to keep the advance moving upward.

During the media coverage about the markets in recent days, several reports noted that the Dow is back to even for the year. As in most negative market environments, the Dow is the beneficiary of investors who move to the bluest of blue chip stocks for security. Other indices have not fared as well and are still negative for 2011. But that could quickly change with a few more days of positive movement.

The chart below shows how the S&P 500 (black line) has compared against the Dow (gold line). The real test now will be to see if major indices can advance above these levels and then build new support. The blue line on the top portion of the chart is a 50-day moving average (MA) of the S&P 500. Last week we noted that major indices were poised to break solidly above their 50-day MAs for the first time in many weeks. That occurred. Now they need to trend above that 50-day MA and sustain their momentum.

The middle portion of the chart is a relative strength index (RSI). The RSI is a good tool to assess market strength and momentum. The 50 level is key. If the RSI can trend above that line, it means that stocks have the strength and momentum to sustain a longer-term advance. If the RSI drops below 50, then another correction is likely.

The bottom portion of the chart is a stochastic oscillator, measuring buying and selling pressure of market cycles. This indicator is at an overbought level, meaning some market weakness is likely in the next few sessions. In recent weeks when this indicator reached an overbought level the S&P 500 tended to sell off sharply and painfully. This time the index might have enough strength for a more muted response. If stocks can work off their excess by moving sideways or mildly correcting, then a more sustained and significant advance might follow. We should not have to wait long to see what the outcome will be.

Flint Stephens

With football season underway, perhaps this is a good time to use a sports analogy to help understand the current position of major market indices. When a football game is close, as the time winds down and the end of the game approaches, there is a palpable increase in tension among the fans in the stadium. In the closing minutes, when the game is in doubt, some fans will close their eyes as one team or the other drives down the field. Everyone knows that one or two key plays will determine the outcome of the game in a short period.

Now, we face a similar situation with major stock indices. Since early August, volatility has dominated market action. There have been plenty of big up and down moves with the bulls and bears taking turns driving the ball down the field.  The game is close, and investors know that time is running out. The bears appear to be the stronger team but the bulls have hung in there and with a break or two could carry the day.

A look at the chart below will help make the situation clearer. The black line shows the daily price movements of the S&P 500 Index over the past year. There was a big decline in the first week of August. Since then, there have been several rallies and corrections without establishing any long-term trend. Usually these periods of sideways volatility can only persist for six or eight weeks before breaking out in one direction or another.

The gold line on the top portion of the chart is a simple 50-day moving average (MA). Notice that the index is currently right at that moving average. In the past three weeks it has reached its 50-day MA twice before and each time could not muster enough momentum to break through. Before stocks can make any significant advance, they must break through and trend above the MA.

The bottom portion of the chart is a moving average convergence divergence (MACD). This indicator reached an oversold level in early August and turned positive later that month. While it has been advancing since then, it has not yet climbed above the zero mark and it actually turned negative again a couple weeks ago. It turned upward again this week and just crossed over to positive. Usually when the MACD establishes a lower higher low like this it is a positive sign for market momentum.

Today this game is still too close to call, but the outcome should be known within a few days or weeks. Investors holding long positions need to be ready to exit quickly if things turn in favor of the bears.

Flint Stephens