Top Picks for a Year-End Rally

Positive year-end seasonality will kick into gear shortly and last through the middle of December. This beneficial period should lift the year's top performers and put a floor under fourth-quarter laggards. The dichotomy favors tech, big caps and commodity-related issues, with banks, small caps and biotech stocks bringing up the rear.

The theory behind this annual impulse is simple enough to understand. Money managers have had a good year, but most of them are still trailing the major averages. The next month will give them a golden opportunity to tidy up year-end results so that it looks like they made all the right moves in 2009. This protects their bonuses and keeps investors happy.

The four- to five-week period corresponds with the interval between November expiration and December triple-witching expiration. This natural lift was once called the "Santa Rally," but there's been a shift backward in this decade, with positive action starting just after Election Day and ending well before the Christmas holiday.

Compressive options strategies are responsible for this calendar-driven mutation. Money managers now use December expiration to lock in annual profits in order to avoid thin-volume shakeout games during the lightly traded period between Christmas Day and New Year's Day. That's one reason why price action can go dead as a doornail in the last trading week of the year.

Last week's strong bounce "feels" like the opening shot of the year-end rally, but we still need to get through November options expiration, which has a well-deserved contrary reputation. Now is a great time to get your shopping list together, however, in hopes of a surge to new 2009 highs in the next few weeks.

As I noted above, this should be a period that favors the year's biggest winners, so I think it's best to stick with the strongest market groups. In that regard, here are my top picks for the year-end rally, subdivided by the best-performing sectors.

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At the time of publication, Farley was long IBM and HPQ, although holdings can change at any time.

Alan Farley is a private trader and publisher of Hard Right Edge, a comprehensive resource for trader education, technical analysis, and short-term trading techniques. He is also the author of The Daily Swing Trade, a premium product that outlines his charts and analysis. Farley has also been featured in Barron's, SmartMoney, Tech Week, Active Trader, MoneyCentral, Technical Investor, Bridge Trader and Online Investor. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.

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