The much-anticipated year-end rally may happen, but it's merely the calm before the storm. As the housing bubble dissolves and the economy slows, watch out in 2006.
By Bill Fleckenstein
As 2005 winds to a close, I have been wrestling with a question: Whether or not the market can hold together for the rest of this year -- leaving the serious business of "the next time down" an issue for 2006. In the face of that unknown, I must look to seasonal market psychology for clues.
Bulls have been feeling pretty bulletproof due to the combination of the "calendar" and what I refer to as the "no-news period." Let me explain the latter -- and how it works into the equation of what the rest of this quarter and calendar year might look like.
Lifecycle of the corporate-spin cycle
Most companies in America are on calendar quarters. In the case of the third quarter, by the time October was finished, we had heard from pretty much all of them. We won't really hear anything further until early December, when we get the mid-quarter updates. Next, we get whatever preannouncements are going to occur. Then in January, we hear from the companies about the fourth quarter.
So in essence, the news period starts roughly with the last month of the quarter and runs through the first month or so of the new quarter. Said differently, the no-news period is the month in the middle of the quarter. (Obviously, this is not precise. Sometimes, due to the way the quarters have aligned vs. expectations, the no-news period can be longer. Also, it isn't strictly a no-news period. It's just a diminished-news period.)
Vaporing thrives in a vacuum
Why does that matter? Because even though most people who operate on Wall Street are adults, they seem to want to believe in childhood fantasies -- witness them describing the economy as a Goldilocks economy and planning for the Santa Claus rally and assorted other dreams.
When I got into the business in the late 1970s, this sort of brazen naiveté would have wiped you out in short order. By my reckoning, individual stocks figured out (or discounted) the news long before they seem to do so today. I attribute this to the fact that people have made so much money basically ignoring all forms of bad news since roughly the mid-1990s that they have invented new rules. (Yes, we did have a nasty 18-month period after the bubble burst. But, as one can see by the craze that's shifted into housing, that sell-off seems mostly forgotten.)
In any case, combine the no-news period (which November essentially is) with folks' belief in the Santa Claus rally, and you have the dynamic for a big rally -- if there is the money to do so (meaning that folks haven't already made the bet) and if what news there is cooperates.
The writing on the drywall
Last Tuesday was an example of the news not cooperating, as Toll Brothers (TOL, news, msgs) was forced to take guidance down for next year. The company's stock declined about 14%, with every other homebuilder hit for 5%, plus or minus. (It is worth noting that since last summer, insiders -- continuing to wax poetic about their business prospects -- sold more than 3 million Toll shares, at an average price of approximately $51.)
Anyone who's read the Contrarian Chronicles for any length of time knows that this is just another data point signaling the demise of the housing ATM and, as a consequence, the consumer and the economy running out of gas. What we don't know is:
• At what rate the process will unfold.
• When it will be recognized and acted on in the stock market.
A potential sign of that recognition: last Tuesday's 3% decline in the shares of Best Buy (BBY, news, msgs), a prominent beneficiary of consumers' spending spree, financed by you-know-what.
I may be making way too much of the dots being connected. But dots will have to be connected about what the demise of the housing ATM will mean before it can collectively mean anything. So, along the lines of what I said earlier, one of the things I'm looking for are signs, outside of the housing stocks themselves, that folks are figuring out what the demise of the housing ATM means.
End-of-year rally or trap?
Back to my original question about the market's path into year-end: I still find it hard to believe that all the people who've made the calendar/no-news bet are going to get paid this year -- though the weight of their sentiment may suffice to keep serious downside action at bay until next year. If so, we might just see a giant flop-and-chop for the rest of the year (with the averages finishing plus or minus a couple percent).
Of course, even if something like that scenario did play out, it doesn't mean there wouldn't be a handful of stocks that might go up a bunch and a handful that might go down a bunch. Again, this is only a near-term scenario, as I continue to be completely convinced that the next move of any consequence will be lower. However, when you're speculating on the short side, as I do, getting the timing right is crucial.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckenstein Capital Web site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of CNBC on MSN Money.
