The months of November, December, and January represent a historically favorable seasonal period for the stock market. Investors commonly refer to this positive phenomenon as the Santa Claus Rally, observes Jim Stack, market historian, top-rated money manager and editor of InvesTech Research.
With the S&P 500 having its second-best performance ever in November, some of the gain that would have otherwise been achieved later in the Santa Claus Rally period have likely been pulled forward.
Historically, when returns in November are 3% or greater, the average performance in December is relatively unremarkable, on average.
On a longer-term basis, the returns for the calendar year following election years have generally underwhelmed compared to those of non-election years. It’s also important to note that both double-digit gains and double-digit losses are observed in post-election years.
Meanwhile, euphoria has returned to the stock market, as speculators in equity options are now the most confident they’ve been since the height of the Tech Bubble in 2000.
Within the options market, investors generally buy call options when they expect prices to rise and buy put options when they expect prices to fall. As a result, taking the ratio of call volume to put volume can be an effective measure of speculation in the stock market, primarily when it reaches extremes.
Options investors have grown increasingly confident over the course of the recovery, with the CBOE Equity Call/Put Ratio recently reaching the most optimistic level in more than 20 years.
Extreme optimism in the Call/Put Ratio often precedes consolidations or major market pullbacks, yet it is important to note that this is a short-term trading tool and not an indicator of long-term shifts in the market cycle. Since the low in March, the buying of puts has slowed while the buying of calls has exploded by a much greater margin.
Euphoria on the part of speculators has been driven largely by new retail traders and fueled by the Federal Reserve’s ultra-easy monetary policies, aggressive fiscal stimulus, and news of multiple COVID-19 vaccines. Market optimism is well-founded, but this level of speculation is reason for caution in the near-term.
While the options market reflects optimism, consumer confidence remains under pressure as COVID-19 caseloads continue to surge. From a macroeconomic standpoint, the recovery remains intact, but it would be difficult for the economic rebound to be sustained if consumer confidence fails to reengage.
Bottom line, the technical and macroeconomic picture is positive and suggests stability going forward. However, there are overarching risks which must be considered when devising a safety-first strategy. Thus, flexibility and following the weight of the evidence will continue to be critical in the months ahead.
