Be Wary of the Bi-Polar U.S. Stock Market

Today's daily dose of bad news about the European sovereign debt and banking crises was ignored by stock market traders that are terrified of missing out on a Santa Claus rally. A successful auction of Spanish sovereign debt and the Census Bureau report that the U.S. housing starts and permits for future construction surged to a 1-1/2 year high in November has propelled the DJIA to a 270 point gain as of mid-day (12/20/11). This moderate dose of positive news is being given far more weight than a report out of Greece from Ekathimerini that "The government has decided to stop tax returns and other obligation payments to enterprises, salary workers and pensioners as it sees the budget deficit soaring to over 10 percent of gross domestic product for 2011."

The low volume of stock market trading exacerbates the impact of news on the market due to all the traders away from their desks taking Christmas holidays. The daily doses of bad news may lead to more down days than up days for the balance of the year, but the up days may be explosive enough to produce  a Santa Claus rally.  However, once 2012 arrives and optimism about a Santa Claus rally is no longer in place to prop up the market, look out below. The deterioration of European economies due to the debt crisis will be daily news, and the contagion will eventually spread to the U.S.  The bi-polar volatility based on the day's new is likely to continue, only with more of a downside bias.

It is only a matter of time until a real bombshell hits. It may be from a run on a bank, a failed sovereign debt auction, or from a threat to oil supplies coming from the Mideast. However, a 500 point down day on the DJIA will likely occur sometime during the next 10 weeks. While I am not so rash as to short the stock market during the remainder of 2011 in the face of a potential Santa Claus rally, I am fearful enough that I am lightening up on my holdings. Today's rally has served as a good exit point. I will not start selling stocks short until the first week of 2012.