All the ingredients for a 'classic year-end rally' are coming together, market expert says

• Markets are primed for a year-end rally, an investor from TPW Advisory says.
• Seasonal trends, overly bearish sentiment, and a buildup of short positioning point to gains ahead.

The stock market's gains this week have investors wondering whether a year-end rally is in the cards, and according to Jay Pelosky of TPW Advisory, all the ingredients are present for a strong run through the rest of 2023.

"I think we're in the stages of a classic year-end rally," Pelosky said in an interview with Bloomberg on Friday. "If you think about it, all the factors are lining up."

Those factors include positive seasonal trends in November and December, as well as a series of market indicators that usually indicate the next move for the market is up.

"You have seasonality, November, December, the best two months of the year," Pelosky listed. "You have sentiment up until the last week that was very, very bearish."

Pelosky pointed out that November and December are often among the strongest months of the year for the stock market, but on top of that, overly bearish sentiment among many different kinds of investors means a bullish shift is coming up.

Hedge funds short positions are the highest in five years, which is a bullish signal for markets because as those investors "cover" their positions by buying stock when they close out a short bet.

Meanwhile, another key group of investors is "off sides," according to Pelosky. Commodity trading advisors, or CTAs, have also been heavily shorting stocks recently, which hints at a possible a bullish turn on the horizon.

"CTAs are completely offsides and will have to buy back an estimated $150B by [year end]," Pelosky wrote in a note last week.

Retail investors also sold the most stock in October than in any month in the last two years, signaling they, too, may be about to ramp up purchases.

Then there are the technical indicators.

The "Zweig Breadth Thrust" indicator has recently signaled a quick pivot from oversold to overbought conditions. To top that off, the number of sectors and market indexes recapturing their 200-day moving average is rising. The Dow Jones just flashed a bullish "golden cross" signal this week, right after seeing a bearish "death cross."

"We know how the [year-end] rally story goes; it starts with [hedge funds] covering their shorts (GS short interest basket up 17% last week) and then extends into [hedge funds]'s going long," Pelosky wrote in last week's note. "They are joined by the CTAs as noted above, then the active managers join in," he added, noting that participation from the retail investor cohort is the final ingredient for the rally to take shape.

"Today's set up is classic [year-end] rally stuff."