Last week, the S&P 500 (SPY  ) finished at an all-time high along with the Dow Jones Industrials (DIA  ) and Nasdaq Composite (QQQ  ). The strength of last week came about despite a bevy of negative developments including slowing industrial production, leaks indicating that 'Phase one' of the trade deal is not a certainty, and technical signals showing distribution while sentiment hits excessively bullish levels.

In a different market environment, it's easy to see market participants reacting by selling stocks - not enthusiastically bidding them up. A previous article listed some intermediate factors favoring further gains. These factors continue to be present. However, they don't explain the unique nature of this rally in which the market is staying overbought and working off these levels with sideways trading before moving higher again.

Negative Equity Fund Flows All Year

This type of market action can be frustrating for bulls and bears. Bears hopelessly watch stocks melt-up, while many bulls are left on the sidelines, as they don't get a dip to buy. One explanation for this market action is that fund managers are underperforming and underinvested, and many are aggressively buying to close the gap, even if they are pessimistic about their outlook.

They are underinvested due to concerns about the global economy and recessionary signals such as the inverted yield curve, slowing manufacturing, and the trade war. At the start of November, the average fund manager was up around 6%, while the S&P 500 was up almost 25%.

Positive Equity Fund Flows

Now that stocks are breaking out, fund managers will be forced to stick to their convictions or chase prices higher. At the end of the year, they will be evaluated against their benchmarks. Severe underperformance means fund managers either lose their jobs or lose investors.

The current market action shows that this career risk trade is now overwhelming the recession-risk trade. All year, fund flows data indicate outflows from equity funds and inflows into bond funds. This series is mean-reverting. Additionally, the Fed is now on hold, interest rates are bouncing back, and leading economic indicators are sending a 'green shoots' message, indicating that the fourth quarter may be the nadir for this slowdown.

Another bullish development for the rest of the year is seasonality. Stocks have a tendency to rally into year-end. This phenomenon is even more pronounced in Year 3 of the presidential cycle, and in years when stocks enter November already up 20%. It's almost like bullish seasonal factors are compounding on top of each other.

2020

Given this confluence of factors, it seems likely that stocks will continue their positive trajectory into 2020. Fund managers are underinvested and underperforming. Fund flows will mean-revert and follow equity performance. Seasonality is also supportive.