The market has surged relentlessly higher (up over 22%) since late August, with only a minor 3-4% pullback during November.
Our contention continues to be that this has been a government-induced rally, and that the economy still cannot grow at an acceptable pace on a self-sustaining basis. If we look back to the action since the rally started (in late August), investors had begun to anticipate additional Fed action in the form of QE2 at that time. Additional Fed action was justified by the fact that economic indicators had started deteriorating again. Most notably, non-farm payrolls declined by 241,000 in the months of June and July after posting strong increases in the prior months. In addition, existing home sales fell off a cliff in the month of July as only 3.84 million units (annualized) were sold compared to figures above 5 million for the previous several months. This poor data provided the justification for further Fed action, and investors knew it.
Once the highly-anticipated announcement came about QE2 in early November, traders used the opportunity to "sell the news" following a roughly 15% increase in stocks over the previous two months. Stocks then drifted lower for most of November as traders began looking for the next catalyst to move the markets higher. And, as expected, they got it. By mid-December the House and Senate had passed a tax bill that not only extended the Bush-era tax cuts across all income levels, but also added a 2% cut in the payroll tax, a lower-than-expected estate tax rate, and tax incentives for businesses that buy new equipment. The anticipation of the tax cut extensions, in addition to the added surprises, kicked the market into high gear once again. The S&P 500 has risen nearly 9% since November 30.