Santa Claus is coming to town, and he's promised to be both naughty and nice.
With Wall Street weathering a series of wicked storms—peril in the auto industry, soaring unemployment, tight credit conditions—stocks have held their ground impressively. That has fueled hopes that the traditional Santa Claus rally may still happen, helped by a plate of government-sponsored goodies.
And Santa is expected to bring President-elect Barack Obama along for the ride. Many investors are optimistic that there will be renewed confidence in the market when the new president takes over on Jan. 20.
"We're looking for a six-week rally," says Kathy Boyle, president of Chapin Hill Advisors in New York. "An Obama-Santa Claus rally."
Of course, market pros say the rally could have a fairly brief shelf life, with pessimism likely to return shortly after Obama takes office amid a flurry of dismal economic news. But in the meantime, the mood is fairly positive.
A handful of factors are precipitating encouragement for the yuletide surge:
- Hundreds of billions in government intervention funds finally taking root and providing some liquidity in the financial sector;
- Obama's plans for infrastructure development are lifting commodities, the building trades and certain parts of the industrials;
- Treasurys are absurdly overbought on flight-to-safety moves and the anemic yields will force investors back into stocks.
As such, investors are lining up to capitalize, with the most popular moves centering on the infrastructure and alternative energy programs planned by the incoming administration, as well as creative bond plays, including exchange-traded funds that reap profits from drops in Treasury prices.
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"There is going to be a rally whether it comes before the beginning of the year or after the first of the year," says Michael Cohn, founder and chief strategist at Atlantis Asset Management. "We're going to get what I think is a very nice rally in anticipation of inauguration."
A rally could actually come sooner, Boyle says. That's because the rush into Treasurys is becoming almost irrational—a sign that the worst is either about to pass or is already gone. That sets up a buying opportunity.
"We're getting ready for a rally," she says. "There's definitely blood in the street at this point. You pick up a paper and all you see is more bad news."
Investors Hang Tough
Yet even amidst that terrible news—the latest being the specter of the auto industry collapse—investors haven't been shaken.
Instead, they've been getting ready to capitalize on the Obama administration's goals. Cohn says domestic companies involved in infrastructure improvements will be natural havens for stocks players.
In addition, he likes other Obama-friendly plays like alternative energy and biotech, basic materials and probably natural gas as opposed to oil.
"You've got to stay with American companies on infrastructure spending and alternative energy, because those are going to be the immediate beneficiaries with whatever the new president does," Cohn says. "They're not going to give out contracts to foreign firms."
Investment professionals are exercising some caution about the form the rally will take and are telling clients to be prepared for volatility all the way through the holiday rally, the pre-inauguration period and in fact throughout all of 2009.
In the meantime, the general view seems bullish.
"What I'm really looking for are real fits and starts, a lot of volatility continuing into next year," says Uri Landesman, head of global growth strategies at ING Investment Management. "What I'm hoping for and expecting is the trajectory is going to be up."
One of the factors giving bulls hope is that Treasury buying has become so overblown that yields have been driven to near-zero in the short term and to 50-year lows in the long term. That means there is almost no value now in putting money into government debt.
Some analysts believe a bubble is about to pop in Treasury prices, which move higher on demand driving yields lower, in recent days to historically low levels.
Mike Larson, analyst at Weiss Research's Money and Markets online newsletter expects investors to start fleeing government debt and looking for other places to put their money, including stocks as well as certain commodities.
"I sure as heck wouldn't be buying Treasurys here. The risk of a big selloff outweighs the risk of big gains at this point," he says. "Technically speaking, this rally on long bonds is virtually unprecedented in terms of its speed and its magnitude."
Indeed, there is a high level of anticipation that the bloom is about to come off the rose for Treasurys.
To capitalize on the expected selloff, Boyle is playing the ProShares UltraShort Lehman 20+ Treasury (AMEX: TBT) ETF that pays twice the inverse of the daily performance of the Lehman Brothers Treasury index of bonds longer than 20 years.
She also advocates the Direxion 10-Year Note Bear (OTC Funds: DXKSX) ETF that pays two and a half times the inverse of the 10-year note's price.
And there are other options in the bond market.
High-quality taxable municipal bonds make one attractive alternative, at yields about 300 basis points higher than Treasurys, according to Bill Glassner, managing executive at Royal Alliance in Cedar Knolls, N.J.
Short-term mortgage-backed securities, with terms generally no longer than three years, also are paying handsome yields without the risk of their much-maligned peers in the subprime mortgage field, Glassner says.
And tax-free municipals and selected corporate bonds also are gaining investor attention.
Glassner also sees the demand for Treasurys waning.
"I would think that the yield curve would steepen and I would think that Treasurys that are under one year will get back clearly into positive territory in terms of yields," he says. "It might not go much above 1 to 2 percent but I can't imagine that it would stay like this for very long."
In addition to his selected bond picks he also thinks that investors will hurry to jump on a stock market rally.
The ability to be nimble could be vital as the market goes through its expected gyrations ahead, but the consensus for now is that the market at least gets a bit of a break.
"I don't think it means that the end is nigh," Landesman says. "I think it's more a sign of the kind of irrationality that I like to see before a big swing. It's going to be a roller coaster for at least the next 12 months, but with a general upward trajectory."For more stories from CNBC, go to cnbc.com.