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The roller-coaster year that started with the possibility of a financial Armageddon is nearly over and finishing on an upbeat note. After a vigorous nine months rally the markets enter the final days of trading at the highs for the year.
Although the equity markets are still well below the 2007 highs, the rebound came with unexpected speed. Since the beginning of the year the Dow has gained 19.9%, S&P 500 is up by 24.7% and the Nasdaq by a stunning 44.95%.
The last trading days of December are traditionally characterized by low trading volume and positive mood, with prices mostly heading up – a so called Santa Claus rally.
Santa Claus rally?
Um, yes. And it’s not just a myth either. It is an uplift in stock prices that starts around, or a few days before, Christmas and typically ends in the first two or three trading sessions of the new year. Historically, during this week or so of trading, the S&P advanced by an average of about 1.5% (since 1950).
While the year-end rally tends to be quite reliable, it’s worth noting that in the years when the markets registered a loss instead, the next year often saw a bear market. So a lack of a Santa Claus rally can be a warning signal for the coming year. (E.g. a lack of a year-end rally in 1999 was followed by a market fall in 2000. A year-end decline in 2007 preceded a disastrous 2008.)
Yesterday the Dow ended up by 0.5%, closing off the holiday week with a 1.85% gain (to 10,520.10). The Nasdaq rallied 3.35% to 2,285.69 and the S&P gained 2.18% to 1,126.48. Expectations are for further advances until the first days of January.
Generally the last few months to the year end tend to be bullish. December is frequently the best single month and November-January tend to represent the best three-month period for equities. 12 of the last 15 year end periods saw stock prices moving up.
There are also several theories or patterns related to January. It is often said that the first four or five trading days of January set the course for the month and often for the first quarter. A selloff in the first days indicates big money (that tends to be reallocated at the time) withdrawing its support from stocks. However, this pattern doesn’t seem to have much historical validity.
January ending higher does frequently mean a good chance for the year to end higher (‘January barometer’; ‘as January goes, so goes the year’). On the other hand, a down January has proven to have less prediction quality as to where the markets will end the year. Overall, the January barometer has been significantly more accurate in bull markets.
Then there is also the so called January effect - a tendency for small cap stocks to rally during January. (The theory is it is due to investors selling at the end of the year to create tax losses, and re-entering positions in January, resulting in a bounce. The effect is visible in the less liquid small and micro caps.) However, the January effect has been significantly weaker in recent years.
Finally, it is said that when the Dow closes below its December low during the first quarter of the next year, it is often a warning sign of lower levels to follow.
The Santa Claus rally is not unique to the US markets. It has also been observed in the FTSE and a number of other stock markets throughout the world.
To end this post, I wish you all….
Merry Christmas and a Happy & Profitable New Year!