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Virtual Water Cooler

Looking for signs of a year-end rally Add to ...

Was the stock market’s sharp upturn to end November a sign that the traditional December rally is on its way? In an e-mail discussion, David Parkinson asks three experts to weigh in on the possibilities – and the risks.

Paul Atkinson, head of North American equities at Aberdeen Asset Management, joins Brooke Thackray, research analyst at JovInvestment Management and Keith Richards, portfolio manager at ValueTrend Wealth Management, to debate the issue.

David Parkinson, The Globe and Mail: Do you think conditions are in place for North American equities to stage a meaningful year-end rally?

Paul Atkinson: Huge macro headwinds persist and that’s been the focus since July, but economic data since September suggest underlying resilience is greater than people expected. Things are still poor, but not as poor as people may think.

Added to that, U.S. third-quarter earnings season showed that corporate performance is holding up well and profitability remains at elevated levels. … Of course, the risks remain on revenues and the lack of growth, but a lot of companies have already learned to live in such a tough environment.

U.S. equity remains a very unloved asset class after a decade of [near]zero returns, and the political deadlock that dominates the headlines means investors are very wary and under-invested. That backdrop of deep cynicism can often lead to a surprise rally.

Keith Richards: I am reasonably short-termed bullish, but longer-term bearish. Clients are asking me if a short-term rally can still occur in light of Europe, China, U.S. situation(s). My answer: Markets can rally in the near term because the leaders of the European Union (which is the main wall of worry of late) have no choice but to quickly come up with a debt “remedy.” I use the word remedy with some trepidation – but the market’s propensity to react to news more than fundamentals lately will likely push a strong rally upon any announcement(s) perceived to be positive.

Perhaps the announcement [on Nov. 30]of central bank co-operation was that catalyst. One cannot argue with the movements by world stock markets after [that]announcement, as the S&P 500 blew through overhead resistance of 1,220. But we will need a follow-through rally through the next, and more significant resistance level of 1,260-ish (which also contains the 200-day moving average) before I would expect the move higher to materialize.

If we don’t get enough news-driven momentum to blow through the 200-day moving average and 1,260 resistance levels shortly, I would suggest that level as the top for this year.

As for the TSX – the chart is a disaster. It’s barely above the 50-day moving average, nowhere near the 200-day MA and the trend is decidedly down. It will follow the S&P 500 up if/as/when that happens in the next few weeks, but will fall harder when markets turn back down later in the New Year.

Brooke Thackray: Typically, December is a strong month for the markets. For the S&P 500, from 1950 to 2010 December was the best-performing month, with an average gain of 1.8 per cent. and positive [returns]77 per cent of the time. It is usually best to err on the side of bullishness during this month.

The market has had a strong rally at the end of November, pushing it close to the resistance level, which currently lies in the same range as the 200-day moving average (1265). Although this makes it harder for the market to move forward, the seasonal trend is still favourable.

Now that we are out of earnings season, it is the economy and the macro-economic environment that is going to largely drive the markets. In the short term it is difficult to predict the European rescue packages, possible downgrades to countries and possible downgrades to banks. It is also difficult to predict the market’s reaction to these events. … Having said that, after last week’s co-ordinated central bank efforts to help Europe, some of the market’s short-term headwinds have lessened, setting the ground work for positive returns in December.

DP: Based on valuations, do stocks look cheap now?

BT: The market is fairly priced by historical standards, sporting a 14 [price-to-trailing-earnings ratio]for the S&P 500. The question remains: Is this attractive given the current economic environment? The answer is that it can move much higher or much lower depending on how the situation unfolds in Europe. The U.S. economy is showing increasing signs of better health and if [the]Europe issue was taken off the table, the U.S. market would probably move higher from this point. Although using P/E ratios for long-term forecasting may be of some use, in the short term they are not helpful. Other shorter-term [technical]indicators … point to a market that is fairly valued, with upside opportunity.

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