Extreme Sentiment Vs. Seasonality

Please Note: I will be on the road this week so posting will be light

Sentiment is stretched to levels where we should see a correction, even in the context of a bull market. The Investors Intelligence bears are at multi-decade lows while the AAII bears are at multi year lows. Option activity has been skewed heavily towards call purchases and Rydex traders are positioned long. It is rare to get such a confluence of extreme readings and this should lead to a correction starting sometime in January.

There are factors that could lead to one last push higher.
  • Traders returning from vacation are more likely to put on bullish positions since most are bullish right now.
  • The second trading day of the year (tomorrow) is seasonally the strongest day of the year.
  • This month is earnings and most companies have a lockup on selling shares until after earnings are reported. There will be few secondaries and little insider selling until later this month.
  • Money comes into the market at the beginning of the year.
Last week, I raised the beta of my short portfolio as a first step towards trying to play a correction. Since the first few days of January are seasonally strong I will wait a couple of days before considering a more aggressive bearish posture.

While some of the seasonal arguments are persuasive I would caution against relying too heavily upon them. Last year a 25%+ plunge started very early in January and "Sell In may and Go Away" was more like "Sell In May and Get Smacked". I pay attention to seasonality but like any other indicator, it is only one of many clues.

No comments: