Market Swoon in December

  • The probability of a market swoon in the early part of December is high.
  • This is a direct result of Central Bank Meetings
  • They don't like tightening monetary policy
  • ECB stimulus is still propping up assets.

First, leading into the election, given what happened with the FBI, money flows that would normally have found their way into the stock market paused.  Specifically, I am talking about the money flows from the ECB stimulus program and even more specifically their direct corporate bond purchases.

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That phase of their program, which was new and officially enacted right after Brexit, which was just a coincidence, has an almost immediate influence on the stock market, although it doesn't have to.  Some of the money that is generated from the sale of corporate bonds to the ECB finds its way into the stock market, and although we cannot be precise as to this relationship, anyone paying close attention to the stock market can see this action regularly.

However, leading up to the election those money flows subsided.  Investors who had excess cash to invest as a result of the ECB bond purchase program, who might have usually put that money to work as soon as proceeds were generated, paused and waited for a decision.  Once that decision came the money flows started again, but in a more aggressive fashion.

In many ways, there was a pent up desire to buy this market leading up to the election, at least there was a buildup of monies available to be allocated, and ever since the election the money flows have been solid, especially in larger cap stocks like those in the dow Jones industrial average.

With the one sided market direction that usually accompanies the Thanksgiving holiday week, the buying interest has seemingly not subsided, even though it reasonably it has transitioned from being a predominately buy side to being just less of a sell side influence; in other words, people are not interested in selling given what they traditionally know about this holiday week.

With that said, it is also my perception that the market has run too far too fast after the election, the Russell 2000 in particular has moved too far too fast, and reasonably so have the other markets, and they are hitting all time high territory right before the FOMC meets to discuss its interest rate policy and before the ECB sets its tapering program.  Both of these are coming in the early part of December.

That sets the stage for a very interesting couple of weeks, following the Thanksgiving holiday.

Although this week will likely be as quiet, and probably one sided, as we have been suggesting, sentiment will likely shift in the week that follows.  The ECB meets on December 8, and during that meaning we expect to learn about its tapering program.  I firmly believe the EC be will announce a tapering program on December 8.

Mario Draghi tried to emphasize the importance of inflation recently, almost suggesting that the stimulus policy that exists today would continue to exist, but he failed to address one important measure.  Specifically, the relationship between the Euro and the U.S. dollar is deteriorating, and if the ECB does not announce a tapering program or the end of its stimulus policy the Euro will likely decline even more against the dollar.  Mario Draghi has not liked that risk in the past.

Shortly after the ECB meets, the FOMC will meet to discuss its decision on domestic interest rates, and interest rates here are going up; Janet Yellen all but assured us that this would happen last week.

As a result, on December 8 we will get information about the tapering program of the ECB, and on December 14 we will get a rate hike from the FOMC, but leading up to December 8 investors will begin to become much more concerned about the influence of monetary policy on economic growth.

That sets the stage for nervousness leading up to the ECB meeting, and probable decline until the FOMC decision is handed down.  From a trading perspective, this would suggest that short interests at the end of this holiday week would probably be relatively well-timed, but in addition long positions on the heels of a swoon, should one come, would be equally as rewarding.

As it stands today, the market has moved too far too fast, but it is unlikely to do anything over the next couple of days because we are in the middle of a traditionally slow week.  Thereafter, the sentiment will change and they will start to think about monetary policy, tapering, and higher interest rates, none of which they like, and when coupled with the all time highs in the market and the overbought conditions that appear to exist in some of the markets, natural drawdowns are likely to follow.