Stock Market Seasonality What is Going to Happen with the Upcoming July 4th Holiday?

By: Angelo_Campione

This issue combines a feature on seasonality with our outlook. With the rally progressing into the July 4th holiday, what will happen next?

The effects of seasonality
Seasonality tends to affect trading but doesn't have an absolute correlation to market direction.

Probably the most consistent effect of seasonality that repeats itself is the lightening of volume during certain times of the year, primarily just before major holidays and into and during the summer months. This lighter volume is often accompanied by an increase in volatility.

One pattern that tends to repeat itself is a reversal around the Independence Day holiday. If the dominant trend is an uptrend, this can lead to a market top going into the July 4th holiday. If the dominant trend is down, it often leads to a reversal that is prominent during this timeframe.

Why does the reversal happen and how reliably does it reoccur year over year? You can only use conjecture as to why the reversals occur, but we will postulate several reasons it may occur, and provide insight into what will happen for the upcoming holiday period on our market outlook section.

We believe that the largest reason that reversals are often seen during this timeframe is the effect of vacations on market participants. "Getting away" tends to provide a perspective that is absent when you are always in the middle of what is happening. It is a sort of a, "seeing the forest through the trees" phenomena where market participants often lack the distance from what is occurring until they can step back for a bit.

Many professional fund managers and other market participants get the chance to step away for long weekends during holiday periods. The traders that open and close positions for funds are immersed in the market action, while the stock pickers and bond gurus tend to have a bit more time to arrive at new thoughts about what the best candidates for their funds might be and perhaps which positions are stale, meaning the reason the positions were taken may or may not continue to be relevant. When the traders get a break, they can take another look at best entry/exit strategies. All of this happens away from the daily grind and comes back together when the markets re-open following the holiday closure. If ideas are broadly different than they were before the "break", the market takes off in another direction. That direction may instigate a market reversal or it may end up with money being pulled from one sector (or industry, asset class, or equity position) and put to work in another.

Volume tends to lighten up when traders take time off, which is quite logical. The volatility picks up as the more junior staffers remain to trade and aggressively move into or out of positions. Without as many market participants, these moves have a more pronounced effect on the markets.

Market closures allow more exogenous events to occur that can cause the market to change direction. It is just probability that the more consecutive days the market is closed, the more days that something important may occur during that closure and that may affect the direction of the market, with a pronounced move when the market re-opens.

Next week, we will cover what is known as the Presidential Election Cycle and how it affects trading and U.S. markets in particular.

Market Outlook and Conclusion

The TED Spread continues to trade in a normal range signaling interbank lending markets are functioning normally.

The price of oil is nearly exactly the same as it was a week ago closing at $69.16 per barrel last Friday (as determined by the near month futures).

Last week, the markets regained some of the ground they lost the week earlier as the major indexes bounced off the lower Bollinger Band. It appears we are rallying into the July 4th holiday which would likely lead to yet another reversal at that time.

How do we come by this conclusion? We have been monitoring some of the major industries in the markets and have noted a decided lack of leadership. While large cap tech, represented by the NASDAQ-100, continues to lead the market higher, other sectors are languishing. The financial sector has lost its upward momentum. Energy appears to have lost its momentum as well as the price of crude oil struggles to move above the seventy dollar level.

Perhaps most telling are the semiconductors which market pundits were very bullish about saying that investments in technology would lead an economic recovery. While the semiconductors did take a leadership position in the rally, since early March that momentum has waned to where the momentum of the semiconductor index has completely stalled.

In addition, the Russell-2000 Index, which tracks the largest 2000 small caps appears to have stalled. Trading in the Russell-2000 demonstrates market participants appetite for risk. Small caps tend to lead the way of recessions so when market participants are bidding these stocks higher, the market is essentially embracing risk and it is a sign of underlying bullishness. That bullishness seems to have waned along with the stalling in price activity.

Finally, by now, long term subscribers know that I monitor the VIX and VXN. The VIX and VXN represent implied market volatility which is the price premium required for option positions. When higher prices are commanded over a given timeframe it suggests that options writers are requiring a higher premium to sell the contracts. In particular, this is tied to put option premiums which means that sellers are requiring higher prices to sell puts, which buyers use as insurance on their long equity positions. Thus, they have become known as the fear gauges. The VIX is specific to the S&P-500 while the VXN is specific to the NASDAQ-100.

Both the VIX and VXN have been trending downward and while we believe that they will continue to work their way lower over the course of the next few years, the trend on an intermediate term basis has been unbroken. That is, since early March of this year, the trend has been downward and reliably contained, on each rally attempt, by the 50-Day Moving Average (DMA).

To be completely honest, we thought that the VIX and VXN would break upward before now and have called for it to occur. We have argued that this occurrence would signal the beginning of a new move lower. That move lower did in fact occur as we predicted it but the VIX and VXN remained contained hence the move higher that followed was also predictable.

We are now monitoring both the VIX and VXN for an expected move higher. If there is a break out of the intermediate term downtrend, it will signal a break down as the VIX tends to move inverse to the S&P-500 and the VXN moves inversely with the NASDAQ-100. This is what we are waiting for to signal it is time to begin to aggressively short some equities and/or the major indexes. It would also be time to sell any short/intermediate term long positions and take profits or buy insurance for long-term positions or core holdings.

We will defer looking at charts until we see a move by the VIX or VXN which breaks the trend. If that doesn't occur in the short term, we may take a look at what is happening in important industries or sectors to illustrate the turmoil in the markets.

Our model portfolio has recently booked profits of 75% to 96% on six positions. We are likely to make significant changes to get ready for the trading action in the coming week.

Our closed positions have netted a Return on Investment (ROI) of more than 230% in our long term portfolio. Our unrealized gains on open positions are up nearly 67% and we have ample cash to enter new long-term positions as well as short/intermediate term positions.

We believe it is time to take advantage of an impending market reversal. To see how we will play this actively, you should consider a subscription to the McMillan Portfolio.

I hope you have enjoyed this weekly article. You may send comments to mark@stockbarometer.com. Please don't be shy in expressing your opinions of what you would like to see covered.

By Angelo Campione

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© 2009 Copyright Angelo Campione - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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