December 23, 2010 | In: Opinion

The Year End Rally

I bought FAZ a few months ago when it was at $13, it is currently trading at trading at $9.64. I admit, I lost money, a lot of money on this stock. I still haven’t sold it and perhaps I won’t sell it unless I sell all my financials. For me, FAZ is a hedge when my financial stocks go down… But now it’s doing more harm than good, because, as everyone probably knows, the year end rally is now upon us.

Year end rallies happen because of six main factors:

1- Losers getting out of the market: A lot of small investors who lost money this year usually start selling their stocks (to claim capital loss on their taxes) in the beginning of December. This selling spree stops at the end of the second week of December.

2- Hope: This is probably psychological, but most people (and investors are people), are more optimistic, hopeful, and full of positive energy at the end of the year. This is because a new year is upon us. A new year that might be better than the current year.

3- Low volume: Most people start taking their vacations at around half the month of December. Since at that time, the losers are out, and because there’s more hope, buy orders do not find sell orders to match them, and stock prices start going up and up (especially small cap stocks).

4- Bad news are scarce and easily digested: A common factor that drags stocks down is bad market sentiment stemming from bad news. But usually news (whether good or bad, and whether political or financial) are scarce at that time. News networks are more interested in giving some peace to their viewer at the end of the year. Even if we have bad news, the market easily absorbs them (since they are, again, scarce) and because of the hope factor that I mentioned above.

5- Losers re-entering the market: Since, as explained later, the year end rally continues through mid January, investors who got out of the market at the end of the year will start re-entering the market, hoping this year will be better. I call the money injected into the market by these investors yo-yo money.

6- Fresh money pumped into the market: Quite a few people want to make money in the next year as part of their New Year resolution, and where else but the stock market, where you can make an infinite amount of money with no risk whatsoever (or so they think). So, they start investing their money by usually buying blue chip stocks (which reminds me, better not sell your BAC stocks until the next year, it’s an undervalued stock).

So how long does the year end rally last?

I have checked several years, and it seems to end by mid January, this is probably when investors start realizing “Hold on a second, there’s nothing different between this year and the previous one, with the exception that now I have a different calendar in my office”. This is when hope fades, volume picks up, and the yo-yo and fresh money has dried up.

Bear ETFs, including financial, technology, and commodities bear ETFs, should be avoided at all costs at this time.

So what do I think about next year? I think from a market perspective the next year will be much better for the American economy, I think Europe will suffer a lot (with all the PIIGS problems, of which we have only seen the tip of the iceberg), but that suffering will no longer have that much of an effect on the American market. I would stay way from European and international companies for next year and focus solely on the US and Canadian companies.

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