Trading the Summer Rally with Precision

As a market contrarian, I wasn’t surprised by the huge rally we saw in the stock market right before Memorial Day. There are statistical tendencies for the stock market to rally before holidays. And the week before Memorial Day, the traditional start for the so-called “Summer Rally” on Wall Street, can deliver impressive short term gains.

Is the Summer Rally Real?

The question is whether the summer rally really exists. And the answer is that sometimes it does. Moreover, there are times when it’s well above average. But those times are often related to specific situations. For example, in 2020, the summer rally was quite the event with the S&P 500 gaining 15% from May 29 to August 31.

While that’s impressive, much of the gain had to do with the Federal Reserve’s aggressive quantitative easing (QE) related to the COVID pandemic and economic crash. The potential for a summer rally should be put in the context of the current status of the market as we reach the summer months.

That said, the three months which comprise the summer season (June, July, and August) can be profitable. As the table below shows, the month of July tends to be the most profitable month of the year when it rises, which is close to 60% of the time. In fact, the take home message of the table is that the odds of a summer rally in any year is about 60%.

Source: BofA Global Research/Bloomberg/Seeking Alpha

Where Are We in 2022?

To gauge the odds of this year delivering a summer rally, we should ask two important questions:

  • What is the posture of the Federal Reserve? and
  • What is the mood of the market?

Both questions are interrelated because the posture and actions of the Fed are the most direct influence on the mood of the market. And in 2022 the Fed has made it clear that it will be raising interest rates, at least throughout the summer if not through the entire year.

As a result, the mood of the market is as foul as it gets.

So are we going to get a summer rally? I’d say the odds are no worse than usual. That’s because everyone is so bearish, and the wall of worry is so high, that the market is extremely oversold.

Watch This Video: Stock Market Rebound Ahead?

And since extremely bearish sentiment often fuels rallies in stocks, combined with the general seasonal tendency for a rally, the pre-Memorial Day jump in stocks may be the signal for a move higher over the next few weeks.

At the same time, because of the Fed and its actions, any rally could be cut short. The best approach is to stick to the long-term goals of your investment plan, and don’t bet the farm.

I recently described a set of rules based on sound stock picking and money management rules which are worth reviewing as you decide how to respond to the current market. These rules dovetail with handy guidelines on how to develop a long-term trading plan.

Here are actionable tips that can be useful in any market:

  • Interest rates can and often affect stock prices. Higher interest rates often decrease stock prices, and lower interest rates do the opposite.
  • Learn the basics of key market sectors. For example, if you’re interested in the housing sector, get a good handle on how the business works such as the effect of interest rates, the best companies to consider, and if there are other sectors related to housing that make sense to learn about such as building materials.
  • Understand how to read price charts. Price charts are usually where the story for a company’s stock comes together. That’s because when investors buy or sell stocks their decisions are catalogued and summarized in the price of the shares. Price charts let you see what that price has been doing for some time.
  • Know that price is the ultimate truth. The market reacts with the information it has at any point in time. Sometimes that information changes rapidly and prices change accordingly. When the market is crashing and your stocks are holding up, there is no need to sell them at that point.
  • When everyone is bearish or bullish, start looking for a trend change.

Seasonal Picks

Finally, if you’re looking for short-term trades during the summer, consider investing in companies whose products may be positively affected by the summer itself. One of them building materials retailer Home Depot (NYSE: HD).

Although volatility in interest rates is generally a negative influence on housing related stocks such as Home Depot, this company often benefits from a strong hurricane season as investors bet on homeowners preparing for potential hurricanes as well as the increased demand for generators after a severe storm.

In fact, the stock may have put in a bottom and could move higher over the next few weeks. This potential move of course seems to have started after the National Hurricane Center issued a forecast for an above average hurricane season to run from June to November of 2022.

Moreover, since the first hurricane in the Pacific could cross over into the Gulf of Mexico in the next few days, it seems as if the forecasters may be correct.

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