Here’s what’s next for stocks

Traders work on the floor of the New York Stock Exchange.

What’s next for markets? Europe and Asian stocks have rallied, commodities are firm on the dollar strength, and even emerging markets are rallying.

Mass hypnosis? Wall Street has convinced itself that the Fed will raise rates two or at most three times next year. Witness bond yields, which are down in the U.S. and Europe, an indication that investors believe the pace of rate increases will be modest.

The Fed’s own internal projections (the so-called “dots”) indicates four raises next year, not two or three. Who’s right? There’s an awful lot of downplaying on the Fed’s projections … don’t take them seriously, everyone says. Really? This is a classic case of Wall Street hypnotizing itself into wanting to believe something. Somebody’s wrong. Careful.

The rally in emerging markets also strikes me as a bit of a head fake. The risk in emerging market economies is that they have been cutting rates to keep their economies competitive, and this has made their currencies cheaper against the dollar and particularly the yen. This can lead to capital flight and makes imports more expensive.

For stocks, once we get past the quadruple witching expiration tomorrow, there is a strong possibility the markets will rally going into the close of the year. We are in a seasonally strong period, tax loss selling historically abates at this time of the year, and many are underweight stocks ahead of Fed.

The wild cards are oil and high yield. If oil can simply stabilize around $35-$36, that would support a rally. If oil rallies and moves anywhere near $40, forget it. Those short oil stocks will cover, and cover fast.

Energy is by far the most heavily shorted sector of the S&P 500. As evidence of how short the market is on oil stocks, Chevron rallied 10 percent in a day and a half on Monday and Tuesday afternoon when oil went from $34 and change to $38.

This is Chevron. This is a company with a $190 billion market cap. Rallying 10 percent. In a day and a half.

As for high yield, with energy companies making up roughly 15 percent of the composition of many high yield funds, any stabilization in oil will also help stabilize high yield.
[“source -cncb”]