Just like little boys and girls now hanging their stockings by the chimney with care, many investors are hoping for a little holiday magic after a hard year. Unfortunately, it’s much more likely that there will be a lump of coal waiting for traders by Christmas than any so-called “Santa rally” that will boost their portfolio.
The Santa rally is one of those seasonal trends that market-timers like to tout. The theory is that year-end rebalancing adds to buying pressure across most asset classes until the turn of the year. Others think it is a boost caused by year-end bonuses being pushed into the market, or that it is purely psychological thanks to the general goodwill of the season (and the fact that many bears and short-side traders are on vacation).
But the idea of a market rally every December is suspect even in a good year — and particularly troublesome in 2011.
Here are five signs that the so-called Santa rally will not transpire this holiday season:
Dangerous December Generalizations
In a 2008 column on this year-end phenomenon, columnist Mark Hulbert crunched numbers and found that December’s “average” strength fails to account for severe volatility. “That’s sort of like the man whose head is in the oven and whose feet are in the freezer and who, on average, feels just fine,” Hulbert wrote.
Yes, the market generally goes up. How else did we get from Dow 2,500 in 1991 to Dow 11,800 at present day? And generally the market also goes up more in December. Since 1896, the Dow Jones Industrial Average has tacked on an average 1.2% each December compared to 0.5% gains averaged in the other 12 months.
But that’s not entirely fair. Taking each month separately, June and July have slightly better average monthly returns than December — so much for “sell in May and go away!”
In short, investing based on generalizations is a dangerous tactic. Try selling investors on that “average” long-term performance of the Dow right now, and you probably will get laughed out of the room. Why would you manage your portfolio in December based on the same flawed logic?
Debt Deadlines Loom
The sovereign debt crisis in Europe and the troubled Congressional supercommittee in Washington have a heck of a lot of work to do. Unfortunately, political gridlock and intransigent citizenry on both sides of the Atlantic are going to make any substantive changes very difficult.
This “pressure cooker” could yield results, but more realistic is that brinksmanship and dangerous rhetoric are going to spook the market. Just look at the summer debt ceiling debate that ultimately resulted in a downgrade to the U.S. credit rating and caused the market to plunge 15% in just a few weeks across late July and early August.
Too many big issues are at play this holiday season for the markets to get their typical break from big news that could sour attitudes on Wall Street. Even if a deal does get reached at the 11th hour in Washington or the euro zone can break through its current spiral of debt-related problems, the market might react severely in the days before any such deals are struck.