The stock market almost always rallies during the last five trading days of the year, and the first two trading days of the next year.

We call it the “Santa Claus rally” – because it happens right around Christmastime. And, it brings gifts to all who are bullish on the stock market.

It’s the most reliable seasonal trend in the stock market. And, it’s probably the main reason so many folks turned bullish last week. Everyone is looking for Santa.

And, of course, that makes me wonder if Santa has already been here and gone.

The American Association of Individual Investors (AAII) just released its latest survey results. It asks its members, “Are you bullish, bearish, or neutral on the stock market over the next six months?” Extreme levels in the responses often provide excellent contrary indicators on market action.

For example, last year as we headed into the Santa Claus rally period, 47% of AAII respondents were bearish, and only 25% of them were bullish. The market was selling off hard. And, most folks thought Santa Claus would be a no show.

But Santa showed up, as he usually does. The S&P 500 rallied 200 points – or 8.5% – during last year’s Santa Claus rally period.

Conditions are a whole lot different this year, though. The most recent AAII survey shows more than 44% of investors are bullish. And, only 20.5% of investors are bearish. It seems that just about everyone will be looking for Santa on Wall Street next week.

That bullish sentiment is confirmed by the action in the CBOE Put/Call indicator, which shows the trading volume in put options against call options. It dipped to 0.63 earlier this week (readings below 0.80 indicate extreme bullishness). In other words, just about everybody in the world is buying call options – a bet on a rise in prices – in anticipation of this year’s Santa Claus rally.

That’s an exaggeration, of course. There must be some children in Outer Mongolia and in Northern Siberia who are not bullish on the U.S. stock market.

My point, though, is that investor sentiment appears to be reaching an extremely bullish level. From a contrarian perspective, that’s a bearish sign. So, it’s quite possible that Santa’s generosity this year will be less than in years past.

The Santa Claus rally is supposed to start next Tuesday and continue until January 3. I do think that stock prices will trend higher during that period. After all, Santa rarely disappoints.

But, in order for that to happen, the market has to do something to shift investor sentiment more towards the bearish side. So, I suspect today and Monday could provide some hard downside action.

Then we can look forward to Santa’s arrival on Tuesday.

Best regards and good trading,

Jeff Clark

Reader Mailbag

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Jeff, this latest app is working simply awesome for me. I used to use the text alerts for notifications, then log on and look at what was just posted.

This latest revision of your app requires only my fingerprint without having to fumble for passwords. Plus, it gives the latest of each subscription, so at first glance I only get what I haven’t seen.

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– Paul

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