Santa Claus Came to Town – and Left

Investors waiting for the market’s annual “Santa Claus Rally” have already missed it, and it’s not even Dec. 1.  The President-elect took the reigns from Jolly Ole Saint Nick and drove the market to new highs.

The problem is super-bullish investor sentiment matched with rosy expectations may result in an early New Year’s market hangover.

The American Association of Individual Investors survey, which measures investor sentiment, clocked in with 50% of investors bullish last week, up from 23.7% in the prior monthly survey. This is the largest stampede into the bullish camp in more than six years.  Extreme bullish sentiment often signals a market top.

Since the election, the S&P is up 3.5% and the small cap Russell is up 12%. Leading the pack is the banking index which is up almost 13% since the Trump win. Right on its heels is the industrials with a 9% gain. Behind them the pack is crowded with materials, consumer discretionary and energy stocks all up about 4%. TrimTabs Investment Research, a firm tracking money flows, estimates that $44 billion poured into exchange traded stock funds in the seven days after the election.

That $44 billion is a lot of money. TrimTabs notes this is the second largest wave of money rushing into the stock market since July 2007.

Most mutual funds are measured on how their performance ranks versus the S&P 500 or another appropriate benchmark. This means they need to invest newly received dollars as quickly as possible. If you’re a fund manager in a race to beat your benchmark every dollar sitting idly by in cash is a potential drag on returns.

So you need to invest the cash fast and smart, and there is some logic behind some of the sector choices portfolio managers are making. Investing in small caps makes sense, for example, because they wouldn’t feel the pain that multinational large cap companies may face if Trump increases tariffs or establishes regulations that slow global trade.

And bank and financial stocks typically profit from higher interest rates. The possibility of increased borrowing to fund Trump’s spending plans has lifted interest rates to 2.3% up from 1.8% pre-election. Materials companies should prosper with his planned infrastructure build and the energy group has been lifted by the prospects of pro-fossil fuel policies. While these assumptions may improve the prospects for some of these stocks, a blanket buy program like the one we’ve just witnessed often ends with some tears.

For one thing, it takes more capital to move higher priced stocks. That $1 million that used to buy you 58,000 shares of Bank of America will now buy 10,000 less shares after the rally. So the bad news is that investors looking for more presents come year end have likely already opened their best ones.

But there is good news. The blind buying going on now gives bears the perfect setup for some great trades next year. At Profit Catalyst I’m selling a few positions that have logged in almost 40% gains in less six months and issuing put option alerts on stocks that may disappoint investors when earnings are unwrapped in January.

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