Originally posted at Briefing.com
With the month of November nearly half complete, a whole lot of participants are still caught up in what happened in October. That is understandable. October gave life to the bears and then it summarily killed the bears — all in a span of about four weeks, which is comparable to the life expectancy of a worker bee.
Briefly, at its low on October 15, the S&P 500 was down 7.7% for the month. When it closed on October 31, the S&P 500 was up 2.3% for the month and sitting at a record high.
The good times have kept rolling, too. As of this writing, the S&P 500 was up 1.0% for the month of November AND at a new record high. The pessimism seen in the early part of October has been supplanted by a wave of optimism that the stock market is poised to have a party-hat finish to the year.
That would not be out of the ordinary.
Decembers to Remember
The Stock Trader's Almanac informs us that, since 1950, the S&P 500 has increased two-thirds of the time in November with an average gain of 1.5% (2.7% in a midterm year) and three-fourths of the time in December with an average gain of 1.7% (1.9% in midterm year).
The average gain of 1.7% in December since 1950 qualifies it as the best-performing month for the S&P 500. November slides in as the third best-performing month (April is second). It should come as little surprise then that "seasonality" gets mentioned a lot this time of year as a basis for expecting the stock market to provide some yuletide cheer for the bulls.
[Hear: Jim O'Sullivan: The Domestic Economy Is Accelerating]
We suspect that marketing message has played a part in helping to boost investor sentiment.
According to the latest survey conducted by the American Association of Individual Investors, 57.9% of respondents say they are bullish. That is well above the long-term average of 38.9% and is the highest reading since the week of December 23, 2010. Only 19.3% of respondents said they were bearish, which is well below the long-term average of 30.4% and one of the lowest readings over the last five years.
Sentiment indicators are regarded as contrarian indicators. They don't always translate into countertrend moves right away, but generally speaking, high levels of bullish sentiment are seen as a warning sign of a potential near-term top (fewer buyers left to buy) while lower-than-average levels of bullish sentiment are regarded as a springboard of rebound opportunity.
One might recall that 2014 didn't get off to the best start. The S&P 500 declined 3.6% in January after bullish sentiment checked in at 55.1% and bearish sentiment touched 18.5% in the week of December 26, 2013.
Per the Stock Trader's Almanac, every down January since 1950, without exception, preceded a new or extended bear market, a flat market, or a 10% correction. Well, at its low in October the S&P 500 was down 9.8% from its September 19 high. The purists out there will say that wasn't 10%, yet we are inclined to score one again for the January Barometer.
It's All Good
What is known now is that the stock market regrouped in a big way. The S&P 500 is up 10.3% year-to-date and is seemingly due for a pullback of some kind when taking into account the sentiment readings and the sheer scope of the gains from the lows in mid-October.
The degree of any pullback is apt to be determined by how cold the headlines are in feeding the thought that the market has gotten ahead of itself.
Signs of recession in the eurozone... renewed military action between Ukraine loyalists and Russian separatists... a nasty earnings warning from a widely-held company... a spike in the dollar... a spike in long-term rates... an inability to pass a continuing resolution to keep the U.S. government operating? One of those things, or all of those things, could do the trick to get a profit-taking sweep going.
We can't say for certain that any of them will happen, yet it's fair to say the stock market over the past month hasn't allowed much room to think of bad things happening. To that end, the CBOE Volatility Index has collapsed, high-yield spreads have narrowed, and cyclical sectors have paced the recovery run. It's all good — or so it seems -- from an outlook perspective.
Alpha in Low Beta
Notwithstanding the huge gains registered since mid-October, it is noteworthy that the top three sectors quarter-to-date are countercyclical sectors: utilities, consumer staples, and health care. Actually, they are also three of the top four best-performing sectors year-to-date, too.
Data Source: FactSet
That disposition fits neatly we think with our contention that one can't afford to be out of the stock market given the Fed's interest rate policy, but that the same policy, which is artificially supporting equity prices, and other matters, has money managers taking a generally cautious approach to the stock market. Accordingly, the alpha in 2014 has been found primarily in low-beta groups.
The recent outperformance of the cyclical sectors could be signaling a shift in that respect, yet with China slowing down, the eurozone stuck in an economic rut, and talk of interest rate hikes from the Fed in 2015, the burden of economic proof to support that recent outperformance is going to fall on the U.S.
What It All Means
It's not going out on a limb to suggest the stock market is due for a pullback. Bullish sentiment readings, exorbitant price extensions in stocks like Alibaba (up 44% in four weeks), and the nagging sense that bad news is being glossed over, all hint as much.
The stock market rally is four weeks old, which is comparable to the natural life cycle of a worker bee. If that worker bee feels threatened, though, it will sting and die a premature death. We wouldn't put it past this market to stage a December rally, but it wouldn't surprise either if it got stung first trying to reach for more honey.
