Santa Claus rally, or round number-itis?

In Free by Cam Hui

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Mid-week market update: As the Dow approaches the magic 20,000 mark, the question for traders is: Will Santa Claus be coming to town this year, or will the market advance stall as it catches “round number-itis”?
 

 

Here is what I am watching.

Risk appetite

Risk appetite metrics are mixed. Fixed income risk appetite, as measured by junk bond performance (top panel), remains in an uptrend with a series of higher highs and lower lows. On the other hand, the relative performance of small caps (middle panel) and high beta vs. low volatility (bottom panel) have not achieved new highs, though they have not turned down to form a negative divergence. Score this indicator as positive to neutral.
 

 

Seasonality

I am much indebted to Callum Thomas for his analysis that showed that the stock market is tracking its bullish seasonal pattern. If history is any guide, the market will see a final price thrust into year-end.
 

 

For another perspective on seasonality, Jeff Hirsch observed that the DJIA has historically risen 66.7% of the time between option expiration (last Friday) and the December year end for an average gain of 0.83%. The corresponding statistics for SPX are 61.9% success rate and 0.84% gain; for NASDAQ 66.7% success rate and 0.86% gain; and 81.0% success rate and 1.82% gain.

Sentiment

In addition, sentiment readings remain supportive based on Callum Thomas’ Europhiameter:

Another weird and innovative indicator, the “Euphoriameter” attempts to capture the level of euphoria (or otherwise) in the market. It looks at forward PE ratios (higher = more euphoric), the VIX (lower = more euphoric), and bullish sentiment (self explanatory!). The VIX and bullish sentiment measures are 12-month smoothed to give a clearer signal and capture the key trends over the longer term. The main point is that it’s starting to surge after a dive down last year, but is not quite at levels of euphoria that would be considered irrational exuberance as such.

 

Bullish sentiment is rising within a positive momentum backdrop, but readings are not at a crowded long yet. There is more room for stocks to run.

The message from gold

As confirmation of my equity bullish outlook, here is another from an intermarket, or cross-asset, perspective. Gold has been one of the asset classes that has shown an inverse correlation with stocks. I have written in the past that gold and gold stocks did not appear to be ready to rally (see Too early to buy gold and gold stocks), which would be a signal of likely equity weakness. Sentiment analysis from Mark Hulbert confirms this view, Hulbert observed that gold timers have been turning bullish in the face of bullion weakness. In short, gold bulls have yet to throw in the towel on bullion, which is contrarian gold bearish and therefore equity bullish.
 

 

VIX Index

Finally, the market has been experiencing a momentum surge that has been accompanied by a series of “good overbought” RSI readings. One cautionary signal that these advances may stall occurs when the VIX Index falls below its lower Bollinger Band. While that hasn’t happened yet, this is something I am monitoring closely.
 

 

When I put it all together, I have to give the bull case the benefit of the doubt for now. My inner investor remains bullish on equities. My inner trader is cautiously positioned for a year-end rally with long positions in SPX and RUT.

Disclosure: Long SPXL, TNA

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