The term Santa Claus rally has been coined over the years for a good reason. Data back over a century reveals that December has the highest probability of any month to be in the green for the TSX and S&P 500 – 77% and 76%, respectively. And the average gain for the TSX at 1.9% is the highest among all months, while the S&P 500’s average of 1.4% is a close 2ndplace after July. This time of year is simply kind to equity portfolios.
Now with the TSX and S&P 500 charging ahead by 6% and 8%, respectively, in October and up 5% and 4% so far in November, Santa certainly came early this year. This does raise the question, though, whether this Santa Claus rally will make it all the way to Christmas. The holiday is a mere four weeks away, which does sound like it is quickly approaching (must start shopping soon). However, four weeks in this ‘bear’ market is a long time, and the market is already rather extended. The S&P 500 is once again bumping up against its 200-day moving average. The bear market rally of the summer months reached this measure as well before making an about-turn.
S&P 500 is bumping up against its 200-day moving average
Our contention has been clear, at the first sign of slowing inflation which is the root cause of this bear market, there was gonna be a strong rally in equities and bonds. And that is pretty much what is occurring, which was kicked started in the September US CPI report that kind of showed inflation may have stopped rising. Then the October reading provided more evidence that inflation may be starting to come back down. Of course, the inflation data wasn’t even a big improvement, but after months of simply getting worse and worse, sometimes just not getting worse is good news.
This does look and feel like a bear market rally. S&P 500 market breadth, measured by the % of index constituents trading above their 50-day moving average, has reached 90% or about 450 companies. It was two months ago that only 15 companies were trading over their 50-day. This bounce has been very widespread. This is also near the peak in market breadth during the summer rally that ended mid-August.
So is this advance for real, or will the recent optimistic fever among investors get trounced once again? The truth is, whenever the final bottom of this bear market is reached, the bounce off the bottom will largely be predicated on ‘hope’ with little fundamental support. That does fit the bill with this bounce. But at some point, hope won’t be enough, and the fundamentals must begin to improve. Today, the fundamentals are not improving and, in fact, continue to go in the opposite direction.
Financial conditions continue to tighten, even with the bounce in the market. Our market cycle indicators are very low and weak. Even the U.S. economy, which remains the relative bright spot, has a year-over-year change in the Leading Index Ten Economic Indicators of -2.7%. Negative readings of this index have a good track record of warning of a material slowdown in economic activity. And then we have earnings. The 3-month revision to earnings estimates for the S&P 500 has turned negative (chart). Unfortunately, this too often lines up with periods of market weakness.
Negative earnings revisions are not supportive of the market
Finally, sentiment is not very bearish anymore, and valuations have risen. Based on the AAII survey, over 60% of investors were outright bearish in late September; now, only 40% of investors are. This is a contrarian indicator, so the more that are bearish, the better for returns going forward.
Maybe the fundamentals will turn around, inflation will cool quickly and smoothly, economic activity will stabilize, and earnings estimates will enjoy positive revisions…maybe. We are going to get another inflation reading in a few weeks, another Fed meeting around mid-December. Based on the price bounce in the market, the news had better be good otherwise, the disappointment will prove painful.
This rally may continue, and who knows, maybe it will make it to Xmas. That being said, after a bounce like this, we would not be shy about taking some off the table, with the belief that better buying levels will materialize.
— Craig Basinger is the Chief Market Strategist at Purpose Investments
Sources: Charts are sourced to Bloomberg L. P.
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