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No Derailments of the Santa Claus Rally in Sight

Paul Rabbitt
Paul Rabbitt
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Stocks are back up against the old highs and some would suggest the rally could fail as overhead supply crushes this fledgling rally. We are convinced the resistance will not stop the rally. Supply-demand factors are attractive for stocks presently. We see no major derailments in sight for a traditional positive finish to the year. Traders are cautioned not to chase stocks that have risen sharply in the past month. However, traders should not take profits yet in stocks that have risen ahead of normal price trends.

Last week stocks rose for a third straight week since bouncing off lows from a correction that ran between August 1 and late October. The Dow Jones industrial average and the NASDAQ climbed 1.5 percent, while the Standard & Poor's 500 rose 1.2 percent.

'Tis the Season for Cash Inflows

Corporate balance sheets are more cash-rich than at any time in the past decade. Inflows are strengthening demand for equities, as sharply rising merger activity, corporate stock-repurchase programs, trust and charitable funding, pension funding, and executive bonuses are the dominant features of supply-demand. In addition, as the holiday season approaches, public offering activity will decline and new supply will shrink.

Moreover, because the stock market has delivered weak returns in 2005, money-managers will tend to invest in the next six weeks as they push for sufficient profits to enable their year-end bonuses.

A Short Squeeze Could Develop

Short-sales have been extremely high at a seasonal time when they are "fighting the tape". In fact, over the past few months the public/specialist short-sales ratio has achieved a 5:1 ratio - the highest we have measured since we began tracking this data in 1977. Rising stock prices could create a year-end scramble to cover short-sales. It is entirely probable that a short-squeeze could give stocks and extra year-end upward boost.

Valuations are Compelling

Stocks are cheaper than bonds or real-estate. The flat market over the year against a background of rising corporate earnings has resulted in a low PE ratio of merely 16x (S&P 500 trailing one year). Historically, when PE ratios have declined to a range between 14-16x, then stocks have rallied nearly 20% in the forward year.

Risks are Low

NYSE margin debt is steady and not excessive. It has held at half the level of five years ago. Margin calls are not a market risk. Oil prices have declined to $58 on warm weather and improvements in U.S. crude production as storm-damaged domestic refinery capacity has come back online. Gasoline prices continue their decline.

Short-term interest rates have doubled in the past year. Rates are likely to rise nearly a full percentage point in the next six months as Alan Greenspan hands over the reins of leadership to the new Chairman of the FOMC. In spite of the 12 rate hikes we have experienced, rates are still low compared to inflation-adjusted historic norms. The relatively low level of rates is insufficient to attract capital away from economic expansion. The U.S. Senate Banking Committee hosts a hearing Tuesday on Ben Bernanke's nomination to be Chairman of the Federal Reserve.

The rise in interest rates has attracted foreign investors into the US dollar. The dollar free-fall versus other currencies, which began five years ago, appears to be over. A by-product of the firm dollar will be a return of global investors to the US equity market.

All in all, This is a good time to invest in stocks. For our top picks every week, see Feel free to take our free 21-day demo subscription.

Paul Rabbitt will be available to take your questions until Monday, November 28. Please use the form below to submit your questions.

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