While the past year was one of the poorer years on record for equity investors, recent developments in the financial markets suggests that the coming year will be a prosperous one. For example, a Santa Claus Rally appears to be fully under way, and numerous fundamental developments suggest that stocks will continue to trend higher during the months ahead.
For those of you that are unfamiliar with the term “Santa Claus Rally,” that phrase refers to a rise in stock prices during the nine-day period between Dec. 24 and Jan. 2 of the following year. Historically, stocks have continued to trend higher for at least a few months following the occurrence of a Santa Claus Rally.
With the S&P 500 index rising 4 percent between Dec. 24 and Dec. 31, stocks clearly appear to be in the midst of a Santa Claus Rally.
Meanwhile, numerous fundamental developments bode well for the future direction of stocks. For example, the Federal Reserve increased the monetary base at the fastest pace in history during the past two months; investors currently have huge stockpiles of cash sitting on the sidelines in low-yielding money market securities; and the projected yield on the S&P 500, relative to yields on bonds, is currently at its lowest level since at least 1962. (The monetary base refers to currency held by the public and funds that commercial banks have on deposit at the Federal Reserve).
In addition, mortgage rates have fallen to their lowest level since at least 1971 when Freddie Mac started its Primary Mortgage Market Survey, and homes are the most affordable since 1994. With the Federal Reserve announcing on Tuesday that it will begin purchasing mortgage-backed securities during early January, I expect mortgage rates to fall even further during the months ahead.
Separately, recent cash flows into and out of equity mutual funds suggest that the majority of stock investors that were considering exiting the equities market have already done so and that only those investors looking to buy stocks are currently active in the equities market.
For example, the most recent data from the Investment Company Institute reveals that while mutual fund investors redeemed the largest amount of money on record from their equity fund holdings during October, redemptions of equity funds slowed dramatically during November.
Meanwhile, the Chicago Options Board’s Volatility Index (VIX Index) has fallen sharply over the past couple of weeks, which suggests that equity investors are now much less concerned about a potentially big decline in stock prices than they were a few weeks ago.
More importantly, my research indicates that the VIX Index will continue to decline during the weeks ahead. That would be a very significant development because stock prices have historically risen sharply during periods when the VIX initially rose dramatically but then fell sharply during the ensuing months.
Of utmost importance, the Democrat-controlled U.S. Congress has virtually assured the American public that it will enact the biggest fiscal stimulus policy since the 1950s shortly after President-elect Barack Obama is sworn into office on Jan. 20, 2009.
In light of the developments mentioned above, I expect stock prices to continue to rally during the weeks ahead and to trend substantially during the first half of 2009.
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