Wall Street hasn’t seen the Santa Claus rally just yet

Ever year while stock traders recover from their Thanksgiving hangovers, they look for what has become the clichéd Santa Claus rally into year end.  But since Donald Trump’s election, stocks have already rallied strongly well beyond the statistical average.  This has begged many to ask: Has Christmas come and gone early this year?

Runners dressed in Santa Claus costumes take part in the Santa Claus Run in Budapest, Hungary December 6, 2015. REUTERS/Bernadett Szabo

Runners dressed in Santa Claus costumes take part in the Santa Claus Run in Budapest, Hungary December 6, 2015. REUTERS/Bernadett Szabo

The answer lies partly in the foundation for the year end rally. By understanding its causes we are in a better position to determine whether they still apply and the rally will continue.

Chris Salamone

 

Does Santa Exist?

The original Santa was certainly real. The ‘Santa Rally’ was first referred to in 1972 by Yale Hirsch in his Stock Trader’s Almanac. It used to refer to a rise in stock prices in the week between the Christmas holiday and the end of the year, a period which is only four or five days.

According to the 2016 Stock Trader’s Almanac “since 1969 the Santa Claus rally has yielded positive returns in 34 of the past 45 holiday seasons — the last five trading days of the year and the first two trading days after New Year’s. The average cumulative return over these days is 1.4%, and returns are positive in each of the seven days of the rally, on average. Nevertheless, each year there is at least one day of declines. Alternative research over a longer period confirms the persistence of these trends: According to historical data going back to 1896, the Dow Jones Industrial Average has gained an average of 1.7% during this seven day trading period, rising 77% of the time.”

But, as with many of these sought after market aphorisms, they develop loosely over time. Any sizeable rally now in December invokes the Santa comparison often due to wishful thinking that the rally will continue until year end but also it sells more media copy to say you ‘believe in Santa’. The term ‘Santa Rally’ now is perhaps wrongly applied to a significant upswing within the extended phase from Thanksgiving to New Year.

If one compares December to other months of the year it is by no means the worst but, since the DJIA started in the late 1890s, the average December return has been a disappointing -0.04%. July fares much better. But the pattern over the last 87 years is clear.

Ed Matts

Ed Matts

The causes are less clear.

‘Christmas Comes But Once A Year’

Each year my wife wants to do Christmas differently. And each year we do the same. Why? Because me and my five children like it that way. Markets also have a habit of repeating themselves.

As Jesse Livermore, the famed stock trader of the first half of the 20 th century, said:

“Wall Street never changes, the pockets change, the suckers change, the stocks change, but Wall Street never changes, because human nature never changes.”

If traders and investors and confronted by similar conditions, they are likely to act in a similar way as their decisions are driven by similar conditions including greed, fear, complacency and even short-sightedness.  This process is further entrenched by algorithmic trading as firstly the data on which those algos are often created is itself sentiment driven data and secondly by the necessarily repeating nature of algos. They will, not might, repeat themselves if confronted by the same conditions.

But can those conditions be similar? Once you strip out the detail and the noise, there are not as many different types of variables as people imagine and their effect on markets are even fewer. Markets are like a ball rolling down {or up?) a hill. The ball will always roll the same way unless the wind blows it in a different direction. And It is remarkable how few different market reactions there are. Of all the markets we cover at Matrixtrade.com the complex US stock market has the fewest different types of patterns.

So what are the specific conditions in December?

Santa’s 7 Elves

There are seven possible reasons that help cause the Santa rally and could still apply even now.

1. Tax. The US tax year ends on December 31 st . In order to crystallise capital gains tax losses to use against other gains, both 401K investors and hedge funds typically sell losing stocks in December, to rebuy them in January. But if the losses had already happened earlier in the year (as is often the case), the net effect is, paradoxically, to drive the market up. The losing stocks do not decline further, but as there is little interest in selling a winning stock, the market stabilises or rallies. Furthermore as more people use tax-sheltered retirement plans they have no reason to sell at the end of the year for a tax loss. In both cases, it serves not to depress but often drive the price up more. Still Applies.

2. Window Dressing .  US Hedge funds and other corporations that trade stocks also report portfolio holdings as well as earnings as of December 31 ST This encourages the sales of losing stocks and the retention of the, often still rising, winning stocks. Still Applies.

3. Cash Charges.   A further hedge fund issue is cash holdings. Investors are charged an AUM [Asset Under Management] fee, typically 2%, and since 2008, cash at bank, or AAA bonds have yielded much less than this, leaving people distinctly unimpressed to see cash on the balance sheet. Another incentive to convert cash into stocks by buying those that are trending higher into year end. Still Applies.

4. Feel Good Factor.   The general feel good factor of the holiday season. At this time of year, we are surrounded by positive messages. Not just goodwill and hope, but a frantic increase in retail commercial activity which is visible to all. There is no mandate to report Black Friday results, so all one hears are the good ones. Still Applies.

5. Illiquidity. Less liquid markets tend to accentuate trend moves. One minor theory is that professional short sellers are on vacation. ‘Bear raider’ firms tend to operate during the summer, when, due to ‘Sell in May’ theory, their likely returns are greatest. Come winter time they may take a long vacation. There may have been a grain of truth in this once but in a world with a much shorter time horizon this argument becomes almost apocryphal. More importantly as many close or wind down their trading for the year, volumes and liquidity does decline. This tends to exaggerate moves and allow those, with reason still to trade, to dominate.  Still Applies.

6. Christmas Cash Flow. Another alleged cause is ‘the Christmas bonus’ in pay packets. This rush of investor money into equities is not substantiated. However, as again Jesse Livermore hinted,  a bent on making more money to pay for Christmas may encourage traders to over-pursue a prevailing trend. “There isn’t a [trader] on Wall Street who has not lost money trying to make the market pay for an automobile or a bracelet or a motorboat or a painting. Of all the hoodoos in Wall Street, the resolve to induce the stock market to act as a fairy godmother is the busiest and most persistent.” Similarly. In a more modern context , in a year where hedge funds have underperformed they will be tempted to chase the year end rally in order in a bid catch up to their benchmark, i.e. buying high betas stocks or leveraging low beta stocks so their beta of their portfolio is higher than their benchmarkStill Applies.

7. Self-fulfilling Prophecy.   The more people expect a Santa rally the more likely they are to buy stocks in the December period. Some attribute the more recent Santa rally phenomenon as front running what was traditionally known as the January Effect where (small cap rather than mid to large cap) stocks would rally at the start of the year.    Still Applies.

The number of internet searches for ‘Santa rally’ reflects the extent to which people are aware of the phenomenon even if they do not intend to buy into it.  Interestingly the apparent interest in the Santa has been subdued compared to previous years probably due to the prevalence of the Trump effect. Only now does it appear to be gaining some traction.

Matrix trade

Matrix trade

Even though December is normally and increasingly dominated by the Christmas spirit from start to finish, what we are seeking is to isolate a sizeable rally of more than 4-5 days. We have already seen one will we see another?

Naughty or Nice

Over the last 16 years the S&P has developed a dominant pattern.

Matrix trade

Matrix trade

For whatever reason, SPX appears to have a propensity to rally in the first half of December. This could generally be caused by anticipation of the Santa rally but consequently is often subject to a mid month sell off to take out any weak premature buyers.  A fake Santa then reminiscent of the naughty French Pere Fouettard who handed out coal and floggings to children as he accompanied St Nicholas on December 6 th .  In this case the rally has clearly been inspired by the election President Trump who promises fiscal expansion instead.  But will it still be subject to a nasty mid month sell off?

The market has been thrown by the election of the potentially radical Donald Trump rather than the ‘more of the same’ candidate Hillary Clinton. An aggressive 5% sell off on the night of his election (in line with the pre-election orthodoxy of Sell Trump Buy Clinton) followed by a sustained break to new all time highs. The market may now be compensating in the shorter term with a similar 5% rally from the immediate pre-election night high.

But there are 3 dominant factors that suggest we are yet to see the Santa rally.

1. Markets tend to trend until the reason for the trend is confirmed or denied (buy the rumor sell the fact). We will only start to know if the Trump Presidency will be inflationary from January at the earliest.

2. Stock markets are acting very similar to the 1929/1987 style blowouts we have touted for the last 3 years.

3. Any one or combination of the specific reasons for the Santa rally are yet to apply.

We have a very clear view what this will entail in the shorter and medium term not just for American stocks. Those receiving our free weekly newsletter https://www.matrixtrade.com/register/ can see how it translates to the German DAX and UK FTSE stock markets and subscribers to MatrixTrade.com can see our projected levels and trading strategies.

This year Donald Trump’s Christmas turkey may not be stuffed or half-baked but will probably be celebrated.

Read the original article on Matrix Trade. Register now at matrixtrade.com for more articles like this, and to see our range of premium subscription services. Copyright 2016.

CHRIS SALAMONE

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About Chris Salamone

About me ( Chris Salamone ) Attorney http://chrissalamone.com http://www.chrissalamone.biz https://vimeo.com/120517175 https://vimeo.com/user37757029 https://about.me/chrissalamone https://www.linkedin.com/in/chris-salamone-2a329b7 1515 N Federal Highway, Suite 300. Boca Raton, FL 33432 561-703-2011
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