A big year-end rally? Don’t get too excited yet.

December is traditionally an up month: Since 1945, the S&P 500 rose nearly 1.5% in all Decembers and advanced in price 73% of the time, according to Sam Stovall at CFRA Research.

But hopes for the usual “Santa Claus rally” may have to be tempered a bit this year.

For one, there is the powerful November rally.

The S&P 500 in November is closing up 11.2%, the fourth biggest gain of all time but only the second biggest gain this year, after April, with a gain of 12.7%.

However, a powerful November rally like the one we have just had often causes problems with the usual year-end “Santa Claus rally,” according to Stovall.

History “suggests that this November’s surge may end up ‘stealing from Santa,'” he wrote in a recent note to clients. Whenever the S&P 500 was up by 5%+ in November, the market posted a sub-par average rise and frequency of gain in December.”

November catalyzed a move into cyclical/value stocks that was much more powerful and sustained than previous value rallies, with significant gains in traditional value sectors like energy and banks, as well gains in broader cyclical groups like industrials and materials. However, growth (technology) has not seen significant selling, as many investors are still skeptical about the value rotation. While defensive/consumer groups like Health Care and Consumer Staples have lagged, they too have produced healthy mid-single digit gains.

This has created the Goldilocks scenario we see now. 

Style investing in November

• Value:   up 14%
• Growth:  up 9%

Sectors in November:

• Energy: up 34%
• Banks: up 20%
• Industrials: up 17%
• Materials: up 13%
• Technology:  up 10%
• Communication Services: up 10%
• Cons. Discretionary: up 9%
• Cons. Staples: up 8%
• REITs: up 7%
• Health Care: up 7%
• Utilities: up 3%

The market has bigger problems than dealing with historic trading patterns. There are very rosy assumptions about the future.

All of this bullishness has many concerned that the market believes corporate America will get through the “Covid Winter” relatively unscathed and will emerge at the start of the second quarter of 2021 with a widely available vaccine that will lead to a reopening of the entire global economy.

With markets at historic highs, there is a lot that can go wrong with that story.

“There is a lot of conviction around the global reflation story,” Alec Young, chief investment officer at Tactical Alpha, told me. Perhaps too much conviction: “Right now, the bull story is intact, but the position is crowded, and everyone knows the talking points.  Where could the consensus be wrong?  What is the blind spot in all this bullishness?”

Markets have rallied around four “buckets:”

1) The reopening: The market is acting like the Covid Winter we are entering will be a minor bump on the road to the Spring reopening and that global reflation is now imminent.

UBS’ Art Cashin is not so sure about the smooth transition to the spring reopening. 

“There are lots of little things that could go wrong in the next several months,” he told me. “Everyone is assuming a smooth vaccine, a smooth transfer of power.” 

None of that is assured, he told me. His biggest concern is geopolitical: “We have a brand new President coming in, there’s been an assassination in Iran, and this new President is going to get tested very quickly, particularly in the Middle East.”

2) Stimulus: The politics of striking a big stimulus deal before the January 5th Senate run-off in Georgia seem increasingly remote.  There is some hope that some limited stimulus may be put in a December 11 budget deal.  But large stimulus bills seem very remote: reports over the weekend indicate that Senate Republicans may now pursue austerity measures in 2021 to curb the deficit.

3) The Georgia Senate races: Veteran trader Joe Zicherman of Stadium Capital has had a profitable year but has options covering his long positions, and has recently bought late January and late March puts.  

The reason: “If the perception occurs that the Democrats are going to win the two Georgia races and the Republicans lose the Senate, and everyone believes corporate and personal taxes are going up, than the market is 25% overpriced,” he told me.

He also noted that there is an abnormally high level of speculative money in the market. “People are buying garbage, and that’s always a sign that people can’t find value.”

3) Vaccine:  The market assumption that vaccine distribution will proceed in a smooth series of rollouts culminating in mass distribution in the early part of the second quarter next year is also questionable, as Cashin has pointed out.  

Former Treasury Secretary Larry Summers believes that by next September enough people will be vaccinated that the pandemic will not be a mega-factor in the economy, but worries that “something could go wrong with the vaccination process,” he said on “Wall Street Week” over the weekend. “The virus could mutate, a new virus could come along, it could turn out that people who have had Covid have more lasting after-effects than we appreciate today, so there are some real risks associated with the long-run playout of Covid.”

4) Valuation: Growth forecasts are being lowered for Q4 2019 and Q1 2020, and there has been little change in the past several weeks in Q4 or Q1 earnings growth for the S&P 500, a reversal of trends earlier in the year, when earnings estimates were rising rapidly.

Cashin, who has seen his fair share of irrational market exuberance in his 60 years on the floor of the NYSE, says traders have levitated themselves into believing in the glorious Spring reopening: “They are buying the reopening package because they are reassuring themselves, ‘I’m not buying for tomorrow, I’m buying for six months from now.’  And maybe that’s right,” he told me, but a lot could go wrong between now and the glorious Spring reopening.

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