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19/12/2014: Are we all set for a Santa Claus Rally?


Has Santa Claus come early this year to deliver equity investors with a big rally? The final two weeks of the trading year traditionally are met with a strong rally on the markets. After an initial sell-off on Monday (DAX down 2.7% on the day, FTSE 100 doe 1.9% and the S&P 500 down 0.5%), the rebound has been significant and equity markets face the prospect of closing the week with strong gains.

Santa

The big turnaround has been made with the oil price which has finally shown tentative signs of stabilisation and the announcement that the Federal Reserve will remain “patient” with regard to the prospect of its tightening cycle.

I now believe that the conditions are set for gains on the equity markets in the coming days. I have focused again a lot on the VIX Index in recent days, noting its sharp rise and subsequent retracement as something to be bullish about now. The chart of the VIX and the S&P continues to show a big negative correlation between the VIX and the prospect for equities. I know that I showed this chart yesterday, but the relationship between the sharp drop in the VIX and the sharp gains on the S&P 500 should not be ignored.

VIX   SPX   19122014

This alone could be enough to whet the appetite for the bulls, and if this decline in the VIX can continue, then investors can enjoy a lucrative time over the Christmas period.

The price of oil has been a key driver of market sentiment in recent weeks and once more it should not go unnoticed that the support for oil has been seen as equity markets have started to pick up again. Equity investors are simply looking for support for oil, which would suggest a balance forming between the supply and demand. In fact, a stable oil price into 2015 would be ideal case scenario for the consumer. If the oil price remains stable then it would suggest that the pseudo tax cut (through the increase in disposable income) is still in play, whilst it also suggesting that the automatic stabilizer of supply and demand could be filtering through the system.

Technically, there is a level of support from 2008/2009 around $60 on Brent Crude, whilst a downside target at $61.40 has already been met. Also, the low at $58.50 on Tuesday remains intact and this is the first time since mid-November that there has been two successive higher lows posted on the daily chart. Furthermore, pulling away from a position of hugging the Bollinger Bands, the consolidation and move back off the bands should now result in a retreat back towards the moving average around which the Bollinger Bands are calculated.

Brent   19122014This could mean one of two scenarios, a rally towards the 20 day ma which is currently around $67.70 (and is falling at around $0.90 per day), or a sideways consolidation whilst the moving average plays catch up. Both of these scenarios would be bullish for equities as it would suggest in the least, stabilisation of the oil price. As can be seen on the chart below, on 7 occasions in the past 6 months, when the price has moved away from the lower Bollinger Band, it has come back to the 20 day moving average. Clearly the caveat to this glass half full argument is that the support at $58.50 is breached and the Brent Crude price starts to fall back towards the next key low at $50. However, for now the support is holding.

So, if this plays out then investor risk appetite should remain positive as we move towards the end of the year and if this is the case then we can expect a nice rebound in the markets to continue. Santa Claus, it is over to you.


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