Santa Claus Came This Year

There is no doubt that Santa Claus arrived on Wall Street this year! With the S&P 500 and the NASDAQ Composite up 14 of the last 17 trading days, the Santa Claus rally posted a return of over 6% on both indices. Not a bad return from the bearded one. But who really is Santa Claus? Is he the historical figure that we all heard about? Or is the bearded one a new Santa, one bringing billions of dollars of cash to Wall Street firms daily, from the Federal Reserve Bank?

Yes ladies and gentlemen, the new Santa is none other than Ben Bernanke. He does have the beard and he did spend the end of this year bringing gifts of large amounts of cash to the once beleaguered Wall Street banks, but after that the similarities stop. I’ve never seen him photographed in a red suit and I’m pretty sure he arrives to work in a car with no reindeer or a sleigh in sight.

Now the Fed through their QE2 program is going to continue to flood Wall Street with billions of dollars through the spring, but will the rally continue? That remains to be seen. Complacency among investors is at almost unprecedented levels. The extreme bullishness is pervasive. It’s as if investors believe that nothing could go wrong. However, it is at times like these that the majority almost always is mistaken and the market does the most damage to highest number of participants.

So where are the warning signs? Oh they are out there and it is in the form of rising interest rates. The bond vigilantes may cause Fed Chair Bernanke some headaches. Recall that the Fed is trying to buy bonds with the intent of keeping interest rates low. They want low interest rates to attempt to stimulate the housing market and to keep corporate lending rates down to motivate businesses to borrow and expand, in an effort to create jobs.

The Fed also wanted to stimulate the stock market to recreate a wealth effect for investors and retirement plans. The success the Fed is having so far with stocks is causing bond holders to rethink their strategy of avoiding stocks and holding safer Treasuries. Rising stock prices are starting to influence droves of investors to sell their bond positions, which are driving bond prices lower and conversely resulting in higher interest rates. How far and how fast rates go up remains to be seen, but printing more money to the tune of hundreds of billions of dollars historically would be considered inflationary. And inflation is bad for bonds as it also drives interest rates higher.

This new conundrum of higher interest rates with an economy struggling to stand its own is not good and will have to come to terms probably sooner rather than later. When? Perhaps next week or maybe money managers will do what they can to sustain the market one more week and wait until after the first of the year. One thing is clear Santa had his rally. The Wall Street gang is celebrating right now. While it is good to enjoy the season and the recent rally, there are some dark clouds on the horizon and to ignore them would be unwise.

Happy Holidays to all and best wishes for a healthy, happy, and prosperous new year.