How We'll Play the 2014 Year-End Rally

With the Dow Jones Industrials and the S&P 500 indices repeatedly making new highs, chances are better-than-good that markets will rally through year-end.

There are lots of reasons why stocks are headed higher, but one in particular is telling.

It's really a simple one, yet too many people have overlooked it; indeed, most wouldn't even give it enough thought.

And that would be a big mistake...

You see, if you understand that one compelling reason, you can pick some winners - and pocket big profits - yourself.

Remember: Greed Is Good

The one almost overriding reason markets will likely keep rallying through year-end is Wall Street players need a good rally to make year-end bonuses and keep their jobs.

Yeah, that's it!

It's not only the 74% of long-only money managers, whose full-year performance, according to Fundstrat, lags the 10% gain this year in the S&P 500 by three percentage points, but hedge funds are lagging and they need a rally, too.

As complicated as markets are, understanding why and how a year-end rally is likely isn't complicated.

It's really just a matter of understanding motivations among Wall Street's players.

In spite of markets making new highs repeatedly this year, it hasn't been a smooth ride.

The bumps throughout the year, especially the mid-October swoon, kept managers on edge and too often took them to the sidelines and out of the action. And worse, a lot of hedge funds were betting against the rising tide of stocks and shorting U.S. government bonds.

It seems those lagging managers need a rally to get a paycheck...

Sudden Dips and Snap-Backs Cost Big Traders Millions

2014 started out well enough, but an ugly 5% dip in late January scared stock players into believing that the long-in-the-tooth rally was nearing a possible end.

That didn't happen.

Stocks rallied back and higher, though not without a few minor bumps here and there.

Then at the end of July, after the S&P 500 poked its head above 2000, we got another quick 5% pullback. Once again there was talk of the rally getting tired and petering out.

Once again, that didn't happen.

By late September stocks made new highs, closing nicely above 2000. Then, seemingly out of nowhere in mid-October, stocks tanked about 8.75% in what seemed like the blink of an eye.

That's when a lot of managers threw in the towel.

Most mutual fund managers sold winners and raised cash, while at the same time aggressive hedge funds shorted momentum stocks and tried to push the market lower.

Unfortunately, hedge funds got a double whammy in the mid-October sell-off.

The mini stock market panic in the United States, which resulted from a sell-off in European stocks when weak European sovereign peripheral countries saw interest rates unexpectedly rise on their government bonds, caused the usual "flight-to-quality" run into U.S. government bonds. The U.S. 10-year yield dropped from about 2.25% down to 1.85% with stunning speed.

The problem for hedge funds was that they were short U.S. government bonds, believing that the coming end of quantitative easing would cause rates to rise. Bond prices fall when yields rise.

But, the flight-to-quality run into U.S. bonds caused bond prices to rise to near record highs, not fall. Hedge funds that were short government bonds got killed when prices went through the roof.

Then, just as quickly as the stock market fell, (actually a good deal more quickly), it bounced to make new highs yet again. And just as quickly as bond prices rallied, they fell back to where they were before the stock market sell-off.

Mutual fund managers and almost all "long-only" money managers (long-only means they don't short stocks) sold stocks, raised cash, and partially went to the sidelines.

Hedge funds had little choice but to lick their wounds and scratch their heads.

And when the picture in Europe suddenly looked brighter, thanks to calming pronouncements from the European Central Bank, U.S. stocks rallied back with a vengeance.

Because of their fears that the October sell-off was the end of the rally, long-only money managers missed the quick run-up to new highs.

Now those managers lagging the S&P 500's positive 2014 performance and hedge funds sitting on losses going into the end of the year all have to figure out how to make money by the end of the year.

Here's the kicker:

Their bonuses and their jobs depend on it.

So, the easiest path for them all is the path of least resistance, which is up, up, and away. That's what they're betting on. They all got into stocks as the bounce was creating new highs, and now they have to push stocks higher so they don't lose out.

That's how Wall Street wants to play through year-end, and why we can benefit from the panic...

It doesn't mean that the market is guaranteed to go higher. There will be some big players who will short stocks up here and try and create a panic. And the market is facing the usual macro-global headwinds, especially Russia entering the Ukraine and the possibility of a full-blown conflict there.

Still, when it comes to Wall Street paychecks, they're going to do whatever they can to get markets higher through the end of their December performance and bonus calculation period ends.

Here's How We Benefit While the Traders Panic

The best opportunities will be getting into big-cap stocks that have lagged in the recent rally to new highs.

Players will look to push those stocks higher as other stocks that made new highs will be looked at as fully valued for the moment, and big-caps with good earnings that haven't moved up as much will be viewed as undervalued and ripe for a bounce.

Big-caps are the way to go because rallying into year-end is about jobs and bonuses this year and managers may want to pull out after their year-end accounting periods have passed.

It's easier to get out of more liquid big-caps than mid-caps and small-caps, both of which look ripe to bounce too, but are less liquid than big household names.
We're almost at Thanksgiving, and time is starting to run short for the bonus pool trades. Keep your eyes open for opportunity just as those traders look for theirs.

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About the Author

Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.

The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.

Shah founded a second hedge fund in 1999, which he ran until 2003.

Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.

Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.

Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.

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