Emotional Rescue: What to Make of the Post-Election Surge?

Key Points

  • U.S. stocks, especially small caps, have surged since the election.
  • Investor sentiment and sector performance show a remarkable shift in a short period.
  • The secular bull market lives on, but some of next year’s performance may get pulled into this year.

Since the pre-election low on November 4, the S&P 500 is up 4.7%, while the Russell 2000 (small caps) is up a whopping 13.8%—rallies which have confounded many investors given the pre-election consensus that stocks would fall on the uncertainty associated with a Trump victory. We did not move into the bearish camp pre-election; but did expect to see a bit more volatility than what has ensued so far.

The rally has had an extreme U.S. bias as well. Global equities, as measured by the MSCI All Country World Index ex. United States, are -1.87% in the past two weeks, while the Wilshire 5000 (the broadest index of U.S. stocks) is +5.61%. That is a spread of 748 basis points in only 10 trading sessions. Cornerstone Macro highlighted this rare occurrence (more than 700 basis points of spread)—it’s happened only 13 other times going back to 1987, when data for the MSCI index was created. Following these occurrences, U.S. stocks had a tendency to give back some of their gains relative to international stocks’ performance and the spread tended to narrow.

Bears morphing into bulls

Investors sentiment has certainly shifted swiftly back to optimism. Two sentiment indexes on which I keep a close eye are from the American Association of Individual Investors (AAII) and SentimenTrader (ST). The former, seen below, shows a significant spike in bullishness—back to the highest level in nearly two years.

Spike in bullishness

Source: American Association of Individual Investors (AAII) Sentiment Survey, FactSet, as of November 18, 2016.

ST has a more behavior-oriented measure of confidence as it looks at what two investor cohorts are actually doing and doesn’t involve opinions. Generally, you want to follow the Smart Money (SM) traders when they reach an extreme in either direction. Examples of some SM indicators include the OEX put/call and open interest ratios, commercial hedger positions in the equity index futures, and the current relationship between stocks and bonds. Generally, you want to do the opposite of what the Dumb Money (DM) is doing at extremes. Examples of some DM indicators include the equity-only put/call ratio, the flow into and out of the Rydex series of index mutual funds, and small speculators in equity index futures contracts.

Smart money versus dumb money comparison

Source: SentimenTrader, as of November 18, 2016.