Momentum sector funds like Consumer Discretionary Select Sector SPDR Fund (XLY), Technology Select Sector SPDR Fund (XLK), and Invesco QQQ Trust (QQQ), up 20% YTD, show a strong correlation between December and YTD returns. Our model predicts a 5%+ December gain for these sectors. However, rising short interest suggests short sellers anticipate reversion, challenging the momentum-driven December effect.

The graph indicates that sectors with the highest returns this year, such as XLY and XLF, also show a reduction in short positions. This suggests that investors are covering their shorts by buying into the top-performing sectors.

Conversely, sectors with the lowest returns, like Health Care Select Sector SPDR Fund (XLV), Energy Select Sector SPDR Fund (XLE), and Materials Select Sector SPDR Fund (XLB), have seen an increase in short positions. This implies that investors are betting against these underperforming sectors.

Returns over the past month, since the election, highlight a trend where less shorted sectors are rallying, while more shorted sectors are lagging behind.

There is a notably strong linear relationship in these trends.

Upon further analysis, we find that in many sectors, there is a strong correlation between December returns and the returns over the first 11 months of the year.

There is a notably strong linear relationship in these trends.

Upon further analysis, we find that in many sectors, there is a strong correlation between December returns and the returns over the first 11 months of the year.

The correlation is particularly strong for momentum-driven sectors: QQQ: 0.84, SPY: 0.7, XLK: 0.7, XLY: 0.75

These sectors have higher momentum, whereas other sectors show weaker or no significant correlation.

Given that these sectors are up by 20% or more, our model predicts a 5% or higher return for XLI, XLY, XLK, QQQ, and the S&P 500 in December.

However, short positions tell a different story. Sectors with higher expected returns are also seeing higher short interest this month. This suggests that short sellers are betting on a reversion, potentially disregarding the December effect.

Momentum sectors like XLK and QQQ project strong December returns but rising short interest hints at reversion risk. While historical patterns favor momentum, short sellers are challenging this narrative, creating a potential clash between bullish sentiment and bearish bets.

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