Will This Be a December to Remember for Stocks?

by Daniel Putnam | November 25, 2013 6:00 am

Will This Be a December to Remember for Stocks?

Once seasonal investment trends become cliche enough to earn a catchy shorthand name, they often lose their effectiveness (think: “sell in May and go away”). Not so for the “Santa Claus rally.”

Over time, the tendency for stocks to rally in December has shown an extraordinary degree of reliability. This has been true through a wide range of market conditions, but especially so when stocks enter the month with a large year-to-date gain already in the books.

Traders should consider the following numbers when trying to determine how to position their portfolios to close out the year:

The full data set can be viewed here[1].

Every year is different, of course, and there’s no accounting for unexpected news events. Still, barring a development that derails the current storyline of improving global growth and Fed policy, there appears to be little on the horizon that could disrupt the historical pattern in the next six weeks.

The 28% year-to-date gain for the S&P is a positive factor as we move into December. Since 1970, the S&P 500 has delivered stronger average performance when it’s already in positive territory coming into the month. In the 28 calendar years in which the index had a positive return as of Nov. 30, it rose 23 times in December (or 82% of the time) for an average gain of 2.96%.

In the other 15 years — when the S&P entered December with a negative year-to-date return — it had an average return of just 1.18%. This helps demonstrate that momentum matters when it comes to the Santa Claus rally.

Why does December skew so positive? One potential factor is that the January Effect — the historical tendency of the market to perform well in the first month of the year — is beginning to unravel, suggesting that investors may be transferring some of their early-year buying into December.

The chart below shows the historical 10-year rolling average of the S&P 500’s January performance. For instance, the data point for 1979 shows the average January return from 1970 to 1979, and so on. This chart illustrates that rolling January returns have gotten progressively worse since the late 1980s.

1112 Will This Be a December to Remember for Stocks?[2]

Even more notably, the average January return for the index since 1999 has been negative at -0.58%. This reverse January effect has been a positive development for the market’s December performance, and it also provides traders with a road map for the six weeks ahead: Buy the dips through Christmas, and pare back on risk thereafter.

Trading on seasonal trends alone is unwise, because unforeseen events can derail even the strongest tendencies. Still, the market’s strength in December has been one of the highest-percentage trends in recent years, and it looks set to continue as long as the headlines cooperate. Trade accordingly.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.

Endnotes:
  1. here: http://investorplace.com/wp-content/uploads/2013/11/Table1119132-165x600.jpg
  2. [Image]: http://investorplace.com/wp-content/uploads/2013/11/1112.jpg

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