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Bracing For Year-End Rally? End Of Fiscal Cliff Marks Beginning Of A Bullish 2013?
Perspective | 23 November 2012
By: Gabriel Gan
Articles (41) Profile

With all eyes on the fiscal cliff in the US, there has been little or no talk about a rally simply because investors are too worried and pessimistic to think or even dream about a rally. Although the Middle East tension did ruffle some feathers, it was nonetheless an excuse for the stock markets to drift even lower while Greece – the perennial “troublemaker” – continued to spook investors after the European Union delayed disbursing funds to help the EU member meet the next round of debt payment.

Of the three sets of worries, we can safely say the Middle East is least worrying as a truce has been called and seasoned investors are already very used to such occasional conflicts while the Greek problem will sooner or later be resolved albeit at the mercy of the EU officials. However, investors fear the fiscal cliff not because the US government will not be able to find a solution. It is no longer an issue of whether it will or will not be resolved; it is more of a question of when they will want to solve this big uncertainty.

The stock market hates uncertainties and the fiscal cliff is one big overhang that investors hate especially when the United States Congress has already shown that they are capable of bickering and doing political horse-trading at the expense of the economy and the stock market. The longer the fiscal cliff is not resolved, the longer will be the uncertainty and, thus, business as well as consumer sentiment be will hit. This is something that the US President and the Congress knows and acknowledged yet they continue to drag their feet and have come up with nothing concrete apart from reassurances that a compromise can be reached.

Since the fiscal cliff refuses to go away, can the stock market still get the year-end rally that investors normally look forward to? Is the historical trend dependable? I have mentioned and provided evidences that historical trends are usually reliable although some trends can be broken in certain years, but we should all look beyond trends to determine the direction of the stock market because macroeconomic news are very important as it drives the sentiment of investors.

Dow Loves To Rally!

The Dow Jones Industrial Average (DJIA) simply loves to rally in December! Since 2,000, the DJIA has risen nine out of twelve years, traded sideways for one year in 2005 and fell only twice in 2007 and 2002.

In 2002 and 2007, we all know by now that those were the years where the September 11 attacks and the financial crisis took place. Since 2012 is not a crisis year for the US and the US stock market has been bullish this year, can we safely assume that the forthcoming December will be a good month for the stock market?

If we base our analysis on historical trends, then the probability of a rally in December in very high but we would have to assume that US economic data continue to surprise on the upside while negotiations over the fiscal cliff do not turn out to be yet another nightmare like when the Congress were arguing about whether or not to raise the debt ceiling.

Since President Obama and House Speaker John Boehner are both confident that there will be a compromise, can we trust that a compromise can be reached? Plenty of investors are expecting a theatre of nightmare but the US government may just surprise all of us by reaching a compromise way before the headline, which will definitely be the catalyst for a year-end rally.

Does China Love To Rally?

Before China rose to prominence, the Hong Kong stock market was tightly correlated with the US stock market so much so that the Hang Seng Index swung wildly in tandem with the DJIA futures.

Times have changed. Although the Hang Seng Index continues to track the DJIA, the Shanghai Composite Index has more or less assumed the role of a market leader and an indicator of some sort. Looking at past trends of both the Hang Seng Index and the Shanghai Composite Index starting from 2000 reveals that both markets actually “dislike” December!

For the past 12 years, the months of December have been rather wretched for both markets with Hong Kong rising only six out of the twelve years with Shanghai Composite Index fearing worse with only four.

What happens if the US stock market rallies but the Chinese and Hong Kong stock markets do not?

There is a likelihood that this will happen as it has been so for the past year or even more. Hong Kong has become more and more reliant on the Chinese economy and its stock market increasing in correlation with the Chinese stock market, hence, we may not get a rally in that part of the world even if the US stock market performs well.

We have witnessed the Shanghai Composite Index doing nothing, even falling, although economic data surprised on the upside and is growing. When the Purchasing Managers’ Index (PMI) was announced on 22 November, the Shanghai Composite Index fell 14 points while the Hang Seng rallied about 200 points.

Are investors sick of the Chinese stock market so much so that nobody wants to buy even when the economy has finally shown signs of a rebound? Is there a confidence crisis? Or are investors disappointed that there will be no stimulus once the economy grows? I believe it is a combination of all three factors that contribute to the state of the Chinese stock market.

STI Loves December Too!

Being a “staunch follower” of the US stock market, the STI an almost perfect correlation with the US stock market, hence, like its counterpart across the Pacific Ocean, the STI rose eight out of twelve times in December.

Mirroring the DJIA, the STI fell in the Decembers of 2002 and 2007 but also fell last year in 2011 due to continued worries about the European economy. Since the STI tracks global and regional indices closely, it is likely that the STI will once again track the DJIA closely while keeping an eye on the Hong Kong stock market.

After hitting a high of 3,110 in October, the STI fell all the way to a low of 2,931 on 16 November. The index rebounded to around 2,990 on 22 November, attempting to close the gap at 2,998 points. Without further catalyst, the index may remain at or around 3,000 points – a psychological resistance – but there is a good chance that the index may try for 3,050 to 3,110 by the end of this year if the year-end rally does arrive.

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