Is a winter rally possible?

The S&P continues to consolidate, as I originally suggested might happen on this site back in early August. People have been asking me why I feel that the market has seen its low at 1120 at this time. They have asked me why I would think there is room for a rally into the winter, given the various walls of worry we would need to climb.

Before I explain why I think there will be a rally over the winter, please understand that I am suggesting that this rally (if it occurs)  is just that: a rally, and nothing more. Sometime over the late winter, I believe that a market peak of 1250-1300 might be achieved for the S&P 500, and thereafter a continuation of the Phase 4 bear market as explained in last week’s blog. So, while my short termed target (by or before the spring of 2012) is for 1250-1300 on the S&P 500, my longer termed target (late 2012) might be around 800 for that same index.

Reasons for a winter rally:

• Seasonality: the best six months of the year cycle begins in November–odds are in favor for stock gains in this period.
• The recent consolidation pattern seems to be holding, even with today’s big selloff. While I won’t discount the potential for a breakdown below the support level of about 1120, it hasn’t broken yet.
• A consolidation pattern will typically lead into a rally after a significant market correction.
• One sentiment indicator that I like to follow – the ISEE put/call ratio –  has been moving into bullish territory (sentiment indicators are contrarian indicators. Thus, too many puts = too many bears = bullish for the market). Watch for an oversold momentum reading  if the markets continue to selloff this week. I’ve mentioned in the past that a bullish ISEE reading within an oversold momentum environment can lead into a gain for the stock markets going forward. Watch for an RSI reading of below 30 for a trigger.
• The American Association of Individual Investors (AAII) survey recently showed 25% bulls vs. 48% bears. This level hasn’t been seen since the market bottom in March 2009. Again, this is a contrarian sentiment indicator suggesting an oversold condition.
• QE3 was announced yesterday–a bond “twist” strategy where the Fed will buy $400B long bonds and sell short dated bonds. This may or may not be bullish  for stocks, but it does keep long bond interest rates low to provide some incentive for investors to seek alternatives to bonds.

September has certainly lived up to its reputation as being the worst month of the year for stocks. Hopefully, the market can complete a consolidation period before the end of October in order to launch into a winter rally.