Could a Santa Claus rally be coming to town?
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Concerns surrounding the US presidential election and a likely Federal Reserve rate rise may temper any expectations of a "Santa Claus" rally in 2016, though not exclude the possibility.
Markets traditionally rally into Christmas, but looking at price levels as at 2 November, the S&P/ASX 200 was up just 2.4 per cent over the year and well off its year-high levels of 5611 in July.
The question now is whether the market could stage a rally into Christmas. Over the past 21 years, December has seen a monthly gain on 16 occasions and a decline just five times, according to Invast analyst Peter Fay.
This is the highest percentage of gains of any month and the average return performance for December is also the second highest over these 21 years. This lends statistical weight to the possibility of a "Santa Claus rally," says Fay.
However, he cautions that worries stemming from the US election and a likely US Federal Reserve rate rise may temper any rally this year, though not exclude the possibility.
The term "Santa Claus rally" came from Yale Hirsch, who was the editor-in-chief of the Stock Trader's Almanac. In 1972 he defined the pattern relating to the S&P 500 as covering the following period: "The last five trading days of the year plus the first two of the New Year."
Shane Langham, a senior private wealth adviser with Philip Capital, has researched the concept extensively as it pertains to the Australian stock market.
"There are seasonal patterns in the markets and one of the strongest and most consistent has occurred at the end of the year and early into the New Year," he explains in a research paper on the subject.
"This is often referred to as the Santa Claus rally or the Christmas rally. One of the potential reasons for this phenomenon is the basis of the American tax year, which runs the same as the calendar year.
"This is generally a strongly bullish time of year for the US markets, and therefore, it's also a strongly bullish time of the year for the local Australian market. There are a lot of investment decisions based around the tax year by institutions, fund managers and the public at large leading into this time of year.
"On top of this, people like to make New Year's resolutions and some of them will be based around what they would like to achieve from the market. Regardless of the reason why, it's a phenomenon we need to look at in order to take advantage of it ourselves.
"It makes sense to focus on higher probability trades or investments and this provides an edge we can utilise."
When looking at the past 36 years, Langham says there are two years in which the market went sideways (1987 and 2008), another four years in which it went down (1981, 1990, 2007 and 2011), while in the other 30 years it went up.
"This provides us with an 83.3 per cent chance that 2016 will see the market move up from around mid-November until the first week of January," he says.
"This is what I would like to call an edge. Before we get too excited and bet the farm that the market is on a one-way trip to the moon, there is still a 16.7 per cent chance that we could be flat or down.
"Either way, I am looking for weakness as an opportunity to position long the ASX 200, but following that up with sensible stop-loss levels and money management just in case Santa doesn't make his way Down Under this year."
According to David Bassanese, chief economist with BetaShares, if there is scope for a Christmas rally it is likely to come following the cessation of the uncertainties following the US presidential election.
"A Hillary Clinton win, though with the Democrats not securing control of both Houses of Congress, appears the most likely and the most ideal scenario for markets," he says.
"Market uncertainty might also be alleviated once the US Federal Reserve finally pulls the trigger on an interest rate increase on 14 December, especially if the Fed then indicates it will be very cautious about the extent to which it raises interest rates in 2017."
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Nicki Bourlioufas is a Morningstar contributor.
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