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Several days ago, I speculated that we would witness "vigorous buying" to start the year, perhaps as early as January 2nd. My rationale was that the vicious selling on December 1st represented cash leaving the market in preparation to return in January to work-around the tax wash sale rule. The market delivered on January 2nd with a 3.2% jump on the S&P 500 and a 3.5% jump for the NASDAQ. Given the monster one-day moves we have seen over the past several months, we might be tempted to yawn. However, as far as history is concerned, we should probably take heed. 2009's start is the third highest start to the year for the S&P 500 since 1950. For comparison, the top two starts to the year are a 3.6% one-day gain in 1988 (less than 3 months after the crash of 1987) and a 3.3% one-day pop in 2003 (the tail-end of the last bear market). For another comparison, we started 2008 with the fourth-worst one-day performance since 1950 (I now chuckle at my description of that day's -1.4% drop as "gut-wrenching").
The buying power of the day was even more convincing given that the marketed opened essentially flat and crept higher all day long. In other words, the market bought its way up instead of just accepting the small number of votes from traders who might have decided to prop up the pre-market futures. The market also maintained its tendency to ignore bad news. This time it was the December 2008 Manufacturing ISM (Institute for Supply Management) Report On Business®:
"Manufacturing activity continued to decline at a rapid rate during the month of December. The decline covers the full breadth of manufacturing industries, as none of the industries in the sector report growth at this time. New orders have contracted for 13 consecutive months, and are at the lowest level on record going back to January 1948. Order backlogs have fallen to the lowest level since ISM began tracking the Backlog of Orders Index in January 1993. Manufacturers are reducing inventories and shutting down capacity to offset the slower rate of activity...Manufacturing contracted in December as the PMI [Performance By Industry Index] registered 32.4 percent, 3.8 percentage points lower than the 36.2 percent reported in November. This is the lowest reading since June 1980 when the PMI registered 30.3 percent. A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting."
So, the good news is that the cash that evacuated the market ahead of the tax wash rule for 2009 seems ready to return. The bad news is that Friday's move was still on light holiday-level volume, and we have now moved into short-term over-bought territory. The chart below shows the situation on the S&P 500. We also have T2108, the number of stocks trading above their 40-day moving average, at 83%. A reading over 70% is typically a poor spot for initiating new longs, and a reading over 80% is typically a short-term sell signal (I will soon have more to say on this relationship using historical data).
When I combine the short-term good and bad news, I speculate that this coming week will likely end where it starts. I will even go so far to guess that January 2nd delivered the bulk of the gains we will see for the month. The next big test comes when we get the details of the coming mega-stimulus package in late January (earnings should be a wash).
Finally, I did a scan for stocks that seem extremely strong. I looked for stocks that are at 40-day highs (going back to Nov 1st and clearing that month's chaos and churn), priced at or above $5, and trading with 40-day average volume above 100,000. I found 247. When I further filtered to 40-day average volume above 10,000,000 shares, I came up with five: Symantec (SYMC), Brisol-Myers Squibb (BMY), Delta Air Lines (DAL), The DIRECTTV Group (DTV), and Caterpillar (CAT). Of particular interest are BMY because it cleared an 11-month high and CAT given it fits well into the current infrastructure investment story. (click here for other ideas for finding strong stocks).
Be careful out there!
Full disclosure: long S&P 500 in an index mutual fund. For other disclaimers click here.