Santa Claus Rally? Don’t Bet On It…

| December 5, 2011 | 0 Comments

Stocks soared last week to their biggest weekly gain since the autumn of 2008.  The Dow Jones Industrials closed at 12,019 for a sensational 7% rise.  It was the second biggest weekly point gain in the long, storied history of the index.

The other major measures of US stock prices also put in big gains for the week.  The S&P 500 jumped 7.4% to just over 1,244.  And the Nasdaq Composite closed 7.6% higher to finish at just under 2,627.

Looking at these figures, you'd think we're starting a major Santa Claus rally.

But the truth is… it's more of a relief Europe's not necessarily sliding into the abyss rally.

I know what you're thinking.  Who cares why stocks are heading higher as long as they keep moving up?

It's a great question.  I mean profits are profits no matter what the reason for the gains might be.  But the reason behind the rally is important to understand in order to gauge the strength and sustainability of the move.

Here's why…

If the rally is due to structural improvement in the economy, it should have strong legs to carry stocks higher over the months ahead.  But if last week's strong move was merely a sigh of relief over Europe finally getting its act together, the gains are more likely to be short-lived.

Unfortunately, it looks to me like the rally is based on the latter reason.

You see, the markets surged on Wednesday of last week after important news about the fate of Europe hit the wires.  The news was shocking to say the least.  In an unprecedented move, the Fed, along with five other central banks (including the European Central Bank and the Bank of Canada), announced a coordinated move to lower interest rates on dollar liquidity swaps.

In other words, the world's major central banks worked together to make it cheaper for banks around the world to trade in US Dollars.  The liquidity infusion is expected to buy Europe more time to come up with a lasting solution to their sovereign debt crisis.

No doubt about it, this is good news.

But it hardly merits a sustained upward move in the markets.

At the end of the day, Europe still has a major crisis on its hands.  A number of EuroZone countries are at risk of defaulting on their debt.  And it will still be up to the stronger countries to bail out the weaker ones to save the EU from breaking apart.

Maybe I'm overly cynical, but I just don't believe a bailout will work longer term.

A bailout can only work if Europe's stronger countries, like France and Germany, will finance the bulk of it.  Call me crazy… but I don't see the conservative German people being willing for long to underwrite the freewheeling spending habits of Greeks and Italians.

In fact, this reality may supplant last week's fantasy by the end of the week.  On Friday, leaders from each of the 27 EU countries are expected to meet to discuss the latest plan to save the fragile union.  If they fail to reach an agreement, last week's gains are as good as gone.

So what should you do?

Be careful about plunging into this rally with both feet.  If I'm right, the so-called Santa Claus rally could easily melt away before it gathers any real momentum.

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Category: Stocks

About the Author ()

Robert Morris is the editor of Penny Stock All-Stars, an investment advisory focused on discovering small-cap and micro-cap stocks that are destined to become the market’s next Blue Chips. The Wall Street veteran and small-cap stock specialist is also a regular contributor to Penny Stock Research. Every week, Robert shares his thoughts with our readers on a variety of penny stock-related topics. In addition to Penny Stock Research, Robert also writes frequently for two other free financial e-letters, ETF Trading Research and the Dynamic Wealth Report. He’s also the editor of two highly successful and popular investment advisories, Biotech SuperTrader and China Stock Insider.

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