“All headlines do is satisfy our need for coherence: a large event is supposed to have consequences, and consequences need causes to explain them. We have limited information about what happened on a day, and [we are] adept at finding a coherent causal story [to satisfy our needs].” -Daniel Kahneman, “Thinking, Fast and Slow”
The third quarter of 2012 ended in unimpressive fashion on Friday, but it is safe to say that the last three months’ aggregate performance took a lot of people by surprise. The quarterly gain was a respectable +5.8%, which was the 8th best return dating back to 2007. This is very good, but not really eye-popping compared to a few others. (The second and third quarters of 2009, for instance, each notched 15% returns.)
So, why has this been one of the most hated rallies in recent memory, especially of late? There are countless reasons to cite – stretched indicators, bullish sentiment, “how far we have come already,” the European mess, the political uncertainty, the fickle economy, an oversold VIX, doubt in the EURO, a non-confirming Transportation Average and strong opposition to QE3 (both the use of it and its potential implications) to name some.
Many market participants have looked at the price action over the last few months and just can’t comprehend how it could be sustained with so much of the above reasons out there. As Dr. Kahneman brings to light, when something really big (good or bad) happens, we all search for headlines to explain it. QE3 can be partially blamed… both the anticipation of, and then the reaction to, it.
But what about the early part of the summer? July had its fair share of fireworks, both up and down. While we didn’t get a trustworthy breakout until August, the quarter’s initial month was important in its ability to weather the erratic earnings season. While the market took its fair share of beatings then, in aggregate, it was able to absorb them very well, as it continuously made higher lows and averted closing below its 50-Day MA at least five separate days.
And this set it up for the August breakout. That breakout, of course, pushed the SPX to, and through, 1400 for the first time since May. Then, on 8/21, it made a new 2012 high. The second half of August was about as boring and quiet a month in recent memory, but the dullness only got the market primed for September’s breakout move.
What could disrupt this run? A marked change of behavior, and despite some cracks to end the month and quarter, it hasn’t fully happened just yet. For comparison’s sake, looking back to earlier this year, we recall that Q1 logged a substantial 12% gain, the third best over the last five years. A new high was immediately logged on April 2nd as the second quarter commenced. But with it, some noticeable divergences emerged, as the RUT, COMP and NDX all failed to confirm this high. Soon thereafter, the market began to bleed, which wasn’t fully bandaged until the June 4th pivot.
Will the same fate be in the cards for the fourth quarter? Are we on our last legs? We’ll have to see. As of now, the market continues its attempt to hold in place in a very challenging environment. Using price action as the final arbiter worked well in Q3, and if nothing else, we’ll continue to look toward it as a guide more than anything else.