Santa rally: Season of goodwill may yet fall flat

This leaves us to wonder whether Santa will have any goodies for the markets this year or whether the Grinch will get there first.

Toward the end of the year, traders tend to rebalance their portfolios and look ahead to the new year. They might sell their losing positions to claim tax losses, and this can depress stock prices.

Not everyone waits until the last minute, though, so stocks usually rebound into late December as tax loss-selling pressure subsides. Then, into January, tax-related trading can create demand as traders look to get back into positions. The investment of bonuses and flows of capital into retirement accounts to take advantage of tax deductions boosts demand early in the year.

Analysis of the average daily return on the S&P 500 index for each day in January in the past 10 and 20 years goes some way to determine whether the Santa Claus and new year rallies exist.

Markets have their ups and downs during these two months, but over time a clear trading pattern has emerged.

December usually starts strongly, with a rally up to about December 5. Markets recede between December 6 and 15 – the peak period for tax loss selling. The Santa Claus rally then runs from the 16th to the 26th. The last few days of the year are often mixed, with volumes light and many traders on holiday.

A rally is common in the first five trading days of the year, although it tends to fade quickly, with markets historically sagging in the middle of the month, particularly between the 11th and the 17th, then trying to stabilise towards the end.

Since 2000, the five best days for stocks in these two months have been December 5, 14, 16, January 3 and 23, with average gains of 0.5 per cent or more. The worst days have been December 20, January 20 and 22, with average losses of more than 0.5 per cent.

This confirms the pattern of market strength in early to mid-December and the potential for weaker markets later in January. Some of that strength comes from a seasonal rebound from historical weakness between August and October. This year, however, that correction didn’t really materialise, in spite of October’s US government shutdown and budget crisis.

Near the end of the year, key US indices remain in uptrends that have been intact for more than a year, with only small corrections along the way. Because so many markets have advanced through the year there may be less tax losses to take, reducing the potential overhang.

On the other hand, the trend of the past year, which has been supported primarily by the influx of cash from the US Federal Reserve’s QE3 programme, may be nearing exhaustion. This means markets may have already priced in high expectations for the coming year, which could limit the upside of holiday season rallies.

It also means markets could be vulnerable to significant profit-taking should any changes to risk or adverse events occur.

Colin Cieszynski is senior market analyst at CMC Markets

Santa claus and the new year rally: influencing factors

Fiscal negotiations

The solution to the October budget crisis was pretty feeble. In spite of all the hand-wringing, the government shutdown and debt ceiling negotiations didn’t have a big impact on the economy and represented a speed bump for stockmarkets.

One would think that, given their drop in popularity, politicians would want to avoid a repeat so soon and would be more ready to deal with the issues.

On the other hand, the limited damage could create complacency among politicians that they can go to the edge without significant repercussions, raising the risk someone may fail to blink at the right time, or make a mistake that could have a deeper impact.

To taper or not?

As the US economy improves, traders have been speculating when the US Federal Reserve may start cutting back its QE3 asset purchases – a move widely known as tapering.

Some thought the Fed would start tapering in September, but it held off – a smart move given the political turmoil of the following weeks.

With the January Fed meeting falling between the next set of US fiscal deadlines and the meeting marking the transition of leadership from Ben Bernanke to Janet Yellen, the Fed is likely to want to show continuity, not bring in changes.

This means if the Fed does not start tapering in December, it would likely be off the table until March at least. With inflation low, employment reports could drive significant speculation on when the Fed may start tapering QE.

To date, signs of earlier tapering have boosted the dollar and weighed on stockmarkets, while signs of extended QE have boosted stocks and hurt the dollar.

Key dates

December 6: US Non-farm payrolls

December 13: Deadline for Federal Open Market Committee to come back with a long-term fiscal proposal

December 18: FOMC meeting and press conference – probably the last chance to taper before March

January 10: US Non-farm payrolls

January 28-29: FOMC meeting changeover in leadership from Ben Bernanke to Janet Yellen

February 7: US debt ceiling deadline