It’s that most wonderful time of the year when, according to historical records, the ‘Santa Claus rally’ comes into play and equity markets tend to surge. December is the month of the year most likely to return a profit on equities, with the S&P 500 posting a positive return during 76% of the months on record – the average gain being 1.6%. However, traders don’t need a very long memory to recall that blind faith in the signal can be costly, as only 12 months ago the December return on the S&P 500 was down -9.18%. This year, there are also some clear geopolitical risks in play.
There’s no strict definition of the Santa Claus rally. The fact that December is the month most likely to post positive results sees many consider the whole month a time to profit from seasonal goodwill. Another definition focuses on the dates 15th-31st December, and some analysis focuses on the last five trading days of December and the first two of January.
IG has run an analysis over every possible combination of time periods on the FTSE 100 and S&P 500 from 1986 to 2015. Those going long on 14th, 15th and 16th December would, according to the report, have caught the biggest rallies in both indices – the average annual return being 2.53% and the win-loss ratio a very tempting 87%. Those who went long on the first trading day of December would typically be holding a -0.23% loss by the middle of the month.
Sam Stovall, chief investment strategist at CFRA Research, has been considering the chance of a mid-December slump. He was speaking with CNBC when he said:
“The market tends to go through a mid-December low, which then represents a good buying opportunity, at least through the end of January.”
Stovall thinks that the decline in 2019 will be no more than 5%. He said:
“I don’t think we need a big pullback or a correction. A mid-single digit decline would be sufficient.”
The phenomenon has been attributed to various factors. One explanation is that fund managers take advantage of the dwindling amount of news flow to concentrate on building positions for the following year. Rotating from one sector to another or scaling up to take account of ‘the January effect’ are both plausible. The markets also typically see trading volumes drop off. While the senior traders enjoy their holidays, junior traders with a mandate to watch the markets have little incentive to proactively engineer short positions or a market correction. With the majority of fund managers being net-long, the communal benefit is for prices to remain high or even drift up until printing at close of business on 31st December, which is when performance bonuses will be calculated.
Seasonal goodwill and the suggestion that traders are investing their annual bonuses are slightly harder to get to grips with. Bonuses might well be calculated on year-end performance, but the majority do not actually hit paychecks until at least one month later. Employers now, quite wisely, hold back on releasing performance-related pay due to the risk of dealing desks ramping up prices to then cash out and move on to work elsewhere.
Stovall picks out the S&P 500 which, being a global index (with a heavy US weighting), demonstrates the global nature of the rally:
“December is the best month of the year. The S&P is up 1.6% on average. It also has the highest frequency of advances, up 76% of the time.”
SPX 500 – Monthly candles Jan 2014-Dec 2019
The IG report data on the UK FTSE 100 states:
“From 1985 to 2015, the FTSE has indeed made an average gain of 2.26% in the last month of the year, rising in value 83% of the time.”
UKX 100 – Monthly candles Jan 2014-Dec 2019
Michael Gable, writing in the Sydney Morning Herald, is already considering the timing required to profit from a possible Santa rally:
“The ASX 200 chart is showing some classic signs of consolidating … When I look at the Australian market, although it is still lagging the US, I see that it is ready to move higher and could provide us with some great returns in 2020.”
Source: The Sydney Morning Herald
ASX 200 – Monthly candles Jan 2009-Dec 2019
The Santa rally is, of course, to some extent a self-fulfilling prophecy, but data specific to 2019 can also be analysed to consider what reasons may be in place for it to not come good this year.
The year-to-date performance from 1stJanuary to Thanksgiving is one indicator. Since 1928, markets that are up by 20% or more by Thanksgiving usually see the S&P 500 push on to post a higher year-end figure. The average gain between Black Friday and the last day of trading is 1.8%.
Looking specifically at the current ‘technicals’, three major indices – the S&P 500, Dow Jones Industrial Average and Nasdaq – are all trading at record highs. Other indices such as the FTSE 100, ASX 200, DAX Index and the Russell 2000 are not breaking completely new ground, though the Russell index did offer another technical long signal by breaking to a 52-week high last week.
Russell 2000 index: (RUSSELL:RUT) Daily candles – April 2018-Dec 2019
There are various factors that could scupper the rally. The US-China trade talks have the deadline of 15th December to contend with. The next round of US trade tariffs is due to come into play on that day, which places the talks in something of a make-or-break situation. The UK general election will take place on Thursday 12th December. Then there are the more regular potential banana skins to contend with. Friday 6th December sees the US release its Non-Farm Payroll data, and the US Federal Reserve FOMC will meet on 10th December to discuss interest rate policy. In addition, OPEC, the COP25 Climate Talks and even NATO are all holding summits in December. Given the timing of these risk factors, 2019 might be a year when traders wait for the mid-December dip before then trying to catch the rally.