Strategy: Early Christmas. Have you noticed? It isn’t even Thanksgiving yet, and yet stores are already decorated for the Christmas holiday and radio stations are starting to play Christmas songs. Hearing too much Christmas music can be bad for your mental health, research shows; psychologist Linda Blair told Sky News: “It might make us feel that we’re trapped—it’s a reminder that we have to buy presents, cater for people, and organize celebrations.”
On the other hand, the stock market often tends to do well after Thanksgiving through Christmas and into the first day of the New Year. This recurring phenomenon has been dubbed the “Santa Claus rally.”
The weakness in the stock market late last week was caused by concerns about whether the Republicans can get a tax reform deal done before Christmas, as promised by President Donald Trump. Nevertheless, there’s already some chatter that the Santa Claus rally could start earlier than usual this year. That’s certainly likely to be the case if Republicans make some progress toward completing a deal.
Last year’s Santa Claus rally has morphed into this year’s meltup. The S&P 500 is up 17.1% since Thanksgiving of last year through Friday. It’s been rising into record territory all this year (Fig. 1). It’s up 20.7% since Trump won the election on November 8 of last year. The latest record high was hit on November 8 when the S&P 500 closed at 2594.38. It is down only 0.5% since then.
Joe and I have been observing since the summer of 2016 that earnings are improving because the energy-led earnings recession is over. Starting late last year, Debbie and I have been noting that the global economy is showing mounting signs of strength. In other words, the market has been boosted by solid fundamentals. Trump’s victory and potential corporate tax cuts were icing on the Yule log cake. In other words, if the Republicans fail to do a deal, that won’t turn us bearish. If they do a deal, we will be concerned about a Santa Claus meltup.
Now let’s sit by the fire and play a medley of meltup songs:
(1) Jingle bull rock. The bulls are all coming home for the holidays. Investors Intelligence’s Bull/Bear Ratio (BBR) soared to 4.47 last week (Fig. 2). That’s the highest reading since March 1987. The 52-week average was 3.17 last week. Readings above 3.0 for this moving average are rare.
Are there too many bulls? Contrarians might think so, but the BBR works better as a contrary buy signal when the ratio is at 1.0 or less than as a sell signal when it is at 3.0 or more (Fig. 3).
The percentage of bears in the Investors Intelligence survey remained at 14.4% last week, the lowest since May 2015 (Fig. 4).
(2) LTEG: Do you fear what I fear? Joe and I are getting a sense of déjà vu all over again as we watch S&P 500 long-term consensus earnings growth expectations (LTEG) going vertical since early last year (Fig. 5). Thomson Reuters compiles this series based on analysts’ consensus expectations for the earnings growth of the S&P 500 companies over the next five years. LTEG has jumped from last year’s low of 9.6% during March to 13.8% last month, the highest reading since April 2002. Leading the way recently is the LTEG for the S&P 500 Information Technology sector at 16.2% during October (Fig. 6).
(3) Valuation: You’d better watch out. The good news is that rising LTEG expectations are making stocks look more attractive based on the ratio of the S&P 500 stock price index to its LTEG (Fig. 7). This PEG ratio for the S&P 500 has declined from a record high (starting in 1995 for this series) of 1.7 during the week of January 28, 2016 to 1.3 at the start of November.
That’s great as long as those LTEG estimates make sense, which they don’t. They are too high, though not as high as their 2000 peaks of 18.7% for the S&P 500 and 28.7% for the index’s IT sector. They seem to be heading in that direction again, which could fuel a meltup by investors driven by FOMO (i.e., fear of missing out).
The more traditional measure of valuation is elevated, but not excessively so. We are referring to the S&P 500 forward P/E, which rose to a cyclical high of 18.0 in early November, the highest since March 2004 but well below the July 1999 peak of 25.3 (Fig. 8). That’s not cheap, but valuation metrics that account for inflation, like the real earnings yield and the Rule of 20, show that the market is fairly valued (Fig. 9) and (Fig. 10).
(4) All I want for Christmas is an ETF. Data available on equity mutual funds and ETFs, compiled by the Investment Company Institute, are available through September (Fig. 11). Collectively, over the past 12 months, these funds attracted $275.2 billion, up sharply from $21.6 billion a year ago and the best such inflow since July 2015. On a 12-month basis, equity mutual funds have had net outflows since March 2016, though the pace has been slowing. The big story is the big inflows into equity ETFs totaling $349.6 billion over the past 12 months.
Investors seem to be especially interested in exposure to foreign equities. The outflows from equity mutual funds have been all among domestic equity mutual funds, which lost $154.6 billion over the past 12 months (Fig. 12). Meanwhile, over the same period, US mutual funds investing globally attracted $80.3 billion.
A similar analysis of equity ETFs over the past 12 months shows that domestic ETFs attracted $210.3 billion, which was slightly below June’s record pace (Fig. 13). While net inflows into global/international equity ETFs was less than for the domestic ETFs at $139.3 billion, that was a record amount.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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