Did Santa and Trump Deliver the Goodies this Christmas?

Investors who bet on the U.S. equity markets in 2016 have been richly rewarded. The S&P 500 Index (SPX) was sitting, earlier this week, at 2,258, up 10.5% YTD (year-to-date). That’s just slightly below the all-time high of 2,271, achieved on Dec. 13 and well above the historic average annual gain. This performance appears remarkable, considering how choppy the markets were at the beginning of the year and prompting the experts to dish out a flurry of downgrades and bear calls.

S&P 500 Index (SPX) 12-Month Returns

Source: NASDAQ

The market has racked up a sizable chunk of those gains after Donald John Trump won the U.S. presidential elections on Nov.8, a phenomenon that has been nicknamed the ”Trump Rally.” The rally has been defying widely held expectations that the markets would react negatively if DJT ascended into the Oval Office, due to his hard-line stance on many international trade treaties.

Download a PDF version of this post.

The negative market sentiment has since changed and many experts now believe that Trump and the Republican-led Congress will get the job done by trimming down taxes and regulations.

S&P 500 Index 3-Month Returns

Source: CNN Money

Does Santa have any gas left in the tank?

It feels like the Santa Rally has come earlier than usual, due to the Trump rally and there are fears that the market might decide to take a breather. The ”Santa Claus Rally” was a term originally coined by famed Wall Street analyst Yale Hirst, way back in 1972, to denote the market rally that frequently comes around the Christmas period (last five days of the old year and first two days of the New Year).

The Santa Rally is usually fueled by heightened shopping activity that comes with the holiday season. So, the first stocks to benefit are usually those that belong to the Consumer Services and Consumer Goods sector. The U.S. economy is hugely reliant on consumer spending, with 70% of the GDP driven by consumer activity. Gains by retail stocks signal that consumers are confident about the future of the economy and stocks in other sectors usually follow suit in a sympathetic rally.

The modern definition of the Santa Rally now covers the whole month of December, since the shopping activity that triggers the rally mostly happens before Christmas. Nevertheless, the equity markets tend to be most vigorous just before Christmas and New Year’s Eve and good gains can be made by day traders who capitalize on this.

And now to our main question: is the Santa Rally done running or can we expect further gains over the remaining two weeks of the year? The short answer is yes; Santa is still alive and well.

Traders will, however, be better served looking outside the usual suspects, thanks to how the Trump rally has changed market dynamics. According to an October report by Goldman Sachs, stocks of companies that see positive earnings revisions have historically outperformed the market. According to the analysts, stocks with positive EPS estimates have outperformed the market by posting annual returns of 23% vs. 15% for the S&P 500 since 2011.

This trend even seems to apply to whole sectors.

The S&P 500 is expected to report earnings growth of 3.2% during the fourth quarter (Q4 2016), with 8 out of 11 sectors expected to report positive earnings growth. Although that growth is a 2% downward revision, when compared to the earlier consensus of 5.2%, it’s still considerably smaller than the trailing 5-year average (-3.8%) and the trailing 10-year average (-4.6%). The overall market sentiment is therefore positive and offers solid ground for the current Santa Rally to continue running.

Performance by the retail sector has, however, been rather anemic in 2016, with the Consumer Discretionary SPDR S&P Retail ETF (XRT) underperforming the market with YTD gains of 6.17% and just 1.35% over the past 30 days. In sharp contrast, the Financial Sector and even Utilities have performed much better than XRT. The Financial Select Sector SPDR Fund (XLF) has rallied 20.72 YTD, and 5.37% over the past 30 days. Meanwhile, the Utilities SPDR ETF(XLU) is up 11.85% YTD and 4.56% over the last 30-day period.

The poor performance by the retail sector can be chalked up to poor earnings growth by the sector. According to data from FactSet, the Consumer Discretionary sector has seen downward EPS growth revision during the fourth quarter, with earnings growth for the sector now expected to clock in at just 0.5% from an earlier consensus of 6.1%. In contrast, the Financial sector is expected to report earnings growth of 14.5% during the fourth quarter, while the Utilities sector is expected to post earnings growth of 20.1% over the same period. The Financial and Utilities sectors are expected to become some of the biggest beneficiaries of policy changes under Trump, hence the sector rallies.

Stocks to watch

The fact that the Consumer Discretionary sector as a whole is expected to record weak earnings growth might mean muted gains by XRT during the Santa Rally. A good 66 out of 82 companies in the Consumer Discretionary sector have witnessed a decline in mean EPS estimates during the quarter and this might explain why XRT has been lagging and might continue lagging behind other sectors.

A better trade strategy might be to cherry-pick stocks that look like obvious winners. Trump recently tweeted the investment roadmap for his administration, saying that he will operate by two simple rules: buy American and hire American. Retail stocks with a strong domestic presence and positive EPS trends are therefore likely to see decent rallies.

Stocks in other sectors that meet similar conditions might also be good candidates.

When to purchase equities

There have been nine holidays during which the U.S. markets have traditionally been closed. Market holidays for the New York Stock Exchange and the NASDAQ over the Christmas period will be as follows:

Christmas Eve Day–Dec. 24, 2016
Christmas Day–Dec. 25, 2016
New Year’s Eve Day– Dec. 31, 2016
New Year’s Day–Jan. 1, 2017

The general strategy by most traders is to buy equities a day or two prior to a holiday. Short-term traders usually sell immediately after the holiday, while longer-term traders prefer to wait until the end of the year. Both plays have proved to be profitable in the past. Selling pressure immediately after a holiday tends to drive prices down, which creates a good entry point for many stocks.

The following are the average returns by the S&P 500 Index for trading activity around major holidays over the past 50 years:

Holiday	Buy 2 days before, sell at year-end	Buy one-day before, sell at year-end
President’s Day*	-0.1%	12.2%
Good Friday	7.3%	17.8%
Memorial Day	-4.7%	22.8%
Independence Day	13.3%	37.3%
Labor Day	16.8%	33.7%
Election Day	17.9%	4.6%
Thanksgiving	4.3%	1.1%
Christmas	-7.1%	15.2%
New Year’s	31.1%	19.6%

Source: Stock Charts

What People Are Saying About 2017

Wall Street remains overwhelmingly bullish about the U.S. equities markets in 2017. Trump promised to undertake the most comprehensive tax reforms since Ronald Reagan, by cutting down corporate tax from 35% to around 15%. This would lead to a 5-7% increase in profits for many companies, leading to upward EPS revisions and multiple P/E expansions.

Additionally, Trump promised a repatriation holiday of 10% to help American companies bring back home the more than $2 trillion cash hoard sitting in overseas accounts in the form of foreign earnings. This would likely lead to a wave of mergers across diverse industries and provide a nice opportunity for traders to engage in another good round of merger arbitrage.

Analysts generally expect the market to enjoy another Bull year in 2017, with some predicting gains of as much as 20%. Others, however, fear that elevated infrastructure spending by the Trump administration might lead to spiraling inflation, which might eventually force the Fed to hike rates quickly and throw the markets into turmoil. Russell Investments is one such analyst and warns the markets could sour in the coming year and end up tumbling to as low as 2100.

If Trump’s pledges were not just instances of campaign hyperbole, we may see the current bull market, the second-longest in history, extend its bullish run by at least one more year.

One Platform. One System. Every Tool

Leave a Comment Cancel reply