Analysts at Ned Davis Research are urging bullish stock-market investors to exercise caution and not get too carried away with optimism. In a recent note, they warned that it may be too early to expect a “Santa Claus rally.”
Measuring Bullish Sentiment
According to Ed Clissold, chief U.S. strategist, and London Stockton, research analyst, the indicators used by NDR suggest that bullish sentiment is currently in the “excessive” zone. They caution that this level of optimism can actually be a contrary indicator and may contribute to the stock market’s historical trend of weak performance in the first half of December.
NDR’s Indicators
NDR’s short-term NDR Daily Trading Sentiment Composite, which incorporates over 20 indicators including sentiment gauges like the Cboe Volatility Index (VIX) and surveys of institutional and retail traders, has reached its highest level of optimism since July 25. It currently stands at an optimistic 76.7.
Additionally, NDR’s crowd sentiment poll, which takes a more intermediate-term outlook and utilizes many of the same indicators, has returned to optimistic territory for the first time since August.
Cause for Optimism
The recent surge in positive sentiment follows the S&P 500’s impressive 8.9% jump in November. This was the largest monthly gain for the index since July 2022 and ranks as the sixth best November performance going back to 1926. The November rally was primarily driven by a decline in the benchmark 10-year Treasury yield, which had reached a high of 5% in October.
Seasonal Weakness Ahead?
Clissold and Stockton believe that the increase in sentiment to potentially overbought levels aligns with the stock market’s historical tendency for weakness in the first half of December. While the S&P 500’s recent performance has been impressive, investors should remain cautious and not overlook the market’s seasonal patterns.
Overall, despite the current optimism, analysts at Ned Davis Research advise investors to proceed with caution and avoid being too complacent. It is important to remember that the stock market can be unpredictable, and a prudent approach is always advisable especially during periods of excessive optimism.
The Surprising Weakness in Stock Market Performance
It may come as a surprise to investors that the months of November and December usually offer the best back-to-back stock-market performance. This weakness has been attributed, in part, to the hype surrounding the “Santa Claus” rally – a term used to describe a narrow window of trading days around Christmas.
However, some on Wall Street use the term more loosely. Technical analysts, akin to shoppers lamenting stores displaying Christmas decorations in October, fume over the misuse of the term Santa Claus rally. Nevertheless, the term often refers to the market’s tendency to rise over the final five trading days of a calendar year and the first two trading days of the following year.
In the table below, we can see a breakdown of the S&P 500’s performance in the five trading days before and after Christmas. On average, the index rises by 0.59% in the pre-Christmas period and another 0.87% in the five days after Christmas. This outperforms the average gain of 0.17% for all five-day periods since 1972.
While this recent weakness may dampen short-term optimism, it could simply be setting the stage for a happy holiday season with a potential Santa Claus rally on the horizon.
