Trading in December: is a Santa Claus rally in sight?

The dramatic year-end sell off in 2018 has some traders wondering if they should avoid entering the market this December, or ride the Santa Claus Rally into the new year.

Historically, the final month of the year is a good one for stocks. The third best on average for the S&P and the Dow, according to MarketWatch. Bolstered by the so-called Santa Claus Rally, where a high volume of activity commonly takes place in the last week of December through to the first trading days of January, the month has become known for its cheerful gains.

Last year was an exception, however, with the S&P 500 recording a 10.1% loss in the month of December. Should traders put off trading in this time frame once again? Some suggest that many of the same concerns expressed in 2018 still persist among traders, which could lead to a similar outcome this year and perhaps start to dispel the Santa Claus rally adage.

On the other hand, Strategas Research Partners say that since 1950 there have only been four instances when the stock market logged back-to-back negative returns within the festive month, suggesting a drop is unlikely to happen again this year. So, should traders expect a Santa Claus rally this year?

 

Why do stocks rally in December?

A common trend among traders is to divest their stock holdings in May to pick up business again in November. The thinking is that stock markets tend to underperform over spring and summer, and boom over the autumn-winter months.

There is good reason to follow suit. Between 1950 and 2013, the Dow, for example, delivered an average return of 0.3% between May and October, according to Forbes. Meanwhile in the same period, between November and April, it delivered a 7.5% average gain. Although there are always exceptions to the rule.

December falls within this booming season, but is additionally boosted by the Santa Claus Rally – a period when increased shopping and optimism fuelled by the holiday spirit causes a rise in trading volumes. The last week of the month is also benefitted by institutional investors who tend to go on vacation. This frees up space for market and retail investors, who tend to be more bullish, to take the lead in the market.

“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,” the Stock Trader’s Almanac says.

“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” - the Stock Trader’s Almanac

 

What happened in 2018?

The year-end sell off that closed 2018 marked the US stock market’s worst December since 1931 – the year in which the industrialised world was experiencing the Great Depression.

Worries of a slowing global economy, continued trade tensions with China and rate hikes by the Federal Reserve triggered the losses the market experienced that year.

During the festive month of 2018, the S&P 500 dropped by over 10%, the Dow by 9.5% and the tech-heavy Nasdaq witnessed a 11.4% drop.

 

How is the market performing in 2019?

While many of the same worries persist this year as they did in December 2018, analysts are optimistic about the end of 2019.

By the end of November, the S&P 500 was heading for the best annual performance since 2013, according to the Wall Street Journal. Measured by the change in their 200-day moving average, roughly 75% of stocks in the S&P 500 are on the increase. In 2018, that same figure came in at less than 50%.

  

Sam Stovall, chief investment strategist at CFRA, recently told CNBC that when a year starts strongly in the months of January and February – as 2019 did with a long rally throughout its first weeks – the S& P 500 has an average total return of 24%, according to data going back to 1945. This means that, if statistics are correct and historical performance is used as an indication of future returns, December should be a strong month.

The market’s performance throughout the year also bodes well for a positive year-end, according to Bespoke. The firm’s data shows that when stocks are up 20% or more by Thanksgiving, the S&P 500 commonly ends the year even higher.

 

Room for volatility

Last week, the Dow and other key indices all reversed sharply as US president Donald Trump revealed that he would re-impose tariffs on Brazil and Argentina.

While there is time for December performance to recover, recent events highlight that the volatility in recent years challenges even the most commonly predicted trends.

How trade tensions shape up over December may well influence how markets perform throughout it. With the Trump administration currently on track to implement new 15% import tariffs on Chinese goods on 15 December, what would normally be a stable period for stock markets may be under threat.