Party On

Mon, Dec 12, 2016 - 10:50am

Originally posted at Briefing.com

A year that started with a bust sure does look like it will end with a bang. The major indices have been in a party mode since Election Day while the Russell 2000 specifically has been the life of the party.

The gains have been extraordinary. Since November 8, the Nasdaq Composite is up 4.4%, the S&P 500 is up 5.1%, the Dow Jones Industrial Average is up 7.1%, the S&P Midcap 400 Index is up 12%, and the Russell 2000 is up 15.7%.

It is a move that few, if any, people saw coming, which is exactly why it came.

Listen to Will the Bull Market Continue in 2017?

Can it continue? No one can say for sure, yet the prospects for a continuation look good on paper.

The Nag

There are multiple factors working in the stock market's favor right now and one nagging factor working against a further extension. Nobody likes a nag, so let's get that explanation out of the way first.

Complacency is the nagging factor.

It seems that everyone went from fearing the election result to now cheering the unfulfilled prospects of pro-growth policies discussed in its wake.

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A market riddled with angst has been replaced by a market riddled with optimism. Nothing bad can happen into year end—or so it seems to be thought.

That confident mentality can be seen in the CBOE Volatility Index, which has collapsed in a move that suggests market participants see little need over the near term to hedge their portfolios for downside risk.

Coupled with a spike in bullish investor sentiment and a sharp drop in bearish sentiment, as measured by the American Association of Individual Investors, and you have a market feeling pretty good about itself right now. That understanding is concerning in the sense that when "everyone" is thinking the same, the opposite often happens.

A heightened level of bullishness, then, stands out as a bit of a contrarian red flag that could cause the post-election rally effort to lose some steam before 2017 dawns (the year, not the price level).

The Land of Plenty

So, then, what is working in the stock market's favor to keep the post-election party going? Plenty.

We see the following items as the primary sources of support:

  • The reluctance to take capital gains before the end of the year as it is assumed there will be a cut in the tax rate on investment income in 2017
  • Seasonality
    • The month of December has been the best-performing month for the S&P 500 since 1950 with an average gain of 1.7%, according to the Stock Trader's Almanac. The S&P 500 is up 2.3% month-to-date as of this writing.
  • The fear of missing out on further gains, which drives sidelined money into the market
  • Underinvested money managers chasing performance in a last-ditch effort to secure annual bonuses
  • The potential for an increased rotation out of the Treasury market and into the stock market
  • The improvement in fundamental underpinnings, namely a pickup in both economic growth and earnings growth, which had been availing itself even before the election result
  • The influence of the momentum trade, which is running in the stock market's favor
  • A broadening of the participation and leadership in the post-election rally
  • The reported eagerness to buy on a pullback by investors who have missed the rally
  • An understanding that some known "scaries" have passed without a bearish response and the recognition that there aren't any known "scaries" into year end
    • Brexit, the US presidential election, the OPEC meeting, Italy's constitutional reform referendum, ECB tapering chatter, and Fed rate-hike talk—they have all been digested with a stunning measure of bullish resolve
  • An embrace of the "Trump put," as traders have visions of tax cuts, deregulation, infrastructure spending, and stronger economic growth in 2017 dancing in their head

What It All Means

The recent past performance of the stock market has been stunning both for its pace and magnitude.

Sure, there have been big rallies before, like the one following the Brexit vote, yet the key difference this time is that the market isn't rallying on a sense of relief that a worst-case scenario didn't unfold so much as it is rallying on the view that a best-case scenario of stronger economic and earnings growth may now be at hand.

That thinking has unleashed a rush of animal spirits that hasn't been seen in some time.

There has always been hope that such growth would be seen, but every six months or so, that hope has gotten reined in by some disappointing economic and/or earnings data, which of course resulted in the "Fed put" being trotted out as a placating influence for market participants.

Read Meet the 2017 FOMC

The Fed put seems less important these days, however, than the Trump put. Perhaps that changes as 2017 unfolds or perhaps not.

Everyone will find out eventually if this stunning stock market rally was a figment of the stock market's repressed imagination or whether it was everything it has been made out to be a leading indicator.

It's a festive time of year for many reasons, yet it has been especially so for the stock market, which we suspect will find more reasons than not to keep its party going into year end or at least keep it from getting busted in a big way in the absence of an exogenous shock.

About the Author

Chief Market Analyst
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