Now that we’re nearly a third of the way through December, it’s time to start talking about Santa Claus and his famous rally. But, before we do, we have to clear up a few things.
First, we have to define what we mean by the term “Santa Claus rally.”
The term “Santa Claus rally” was first coined by market analyst Yale Hirsch in 1972 in The Stock Trader’s Almanac. As originally defined, the period of time covered by the term spanned the last five trading days of the old year and the first two trading days of the new year.
The performance of the market during these trading days is used as an indicator of how well the market is likely to do during the new year. According to Jeff Hirsch (Yale’s son), a strong performance during this period can be a good sign for the market, but “If Santa Claus should fail to call, bears may come to Broad and Wall” — the location of the New York Stock Exchange.
However, since 1972, many analysts and commentators have been using the term Santa Claus Rally to cover the period of time from the beginning of December — or even as early as Black Friday — until Christmas.
Apparently, they didn’t get the memo from Hirsch.
So, we have to decide which definition we’re going to use.
With all due respect for Hirsch, we’re going to stick with the new definition of the Santa Claus Rally for two reasons. First, we don’t think one can really know with any degree of certainty how well the stock market is going to do during a given year by watching the performance of the market during a span of just seven trading days. Second, the impact of the economic forces most closely tied with the holiday season — shopping, shopping and more shopping — is felt on Wall Street before Christmas, not after.
Discretionary Vs. Nondiscretionary
When conducting an intra-market analysis of the stock market, one of the first relationships to check is how well discretionary (cyclical) stocks are doing compared to nondiscretionary (noncyclical, or staples) stocks.
Typically, when the market is strong, discretionary stocks — like Walt Disney Co. (DIS), Home Depot (HD) and Nike (NKE) — outperform nondiscretionary stocks like Procter & Gamble (PG), Coca-Cola (KO) and Philip Morris (PM). Conversely, when the market is weak, nondiscretionary stocks outperform discretionary stocks.
To see which stocks are outperforming and which are under-performing, we can construct a relative strength chart comparing the Consumer Discretionary SPDR (XLY) and the Consumer Staples SPDR (XLP) — two funds that track a broad cross-section of these various stocks.
When the relative strength chart is moving higher, it indicates that XLY is outperforming XLP. As you can see in Fig. 1, discretionary stocks have been outperforming staple stocks for most of 2015.
Fig. 1 — Relative-Strength Chart comparing the Consumer Discretionary SPDR (XLY) and the Consumer Staples SPDR (XLP).
So, how does the Santa Claus Rally fit into all of this?
The holiday season is the poster child for discretionary spending. As such, this is a time of year when discretionary stocks should be outperforming nondiscretionary stocks.
However, that is not what we are currently seeing. As you can see in Fig. 2, discretionary stocks have been underperforming nondiscretionary stocks during the month of December.
Fig. 2 — Relative-Strength Chart Comparing theConsumer Discretionary SPDR (XLY) and the Consumer Staples SPDR (XLP).
Part of this is likely due to the “buy the rumor, sell the news” phenomenon that so often occurs in the market. Whenever traders on Wall Street expect to see something — like a Santa Claus Rally — they start taking action earlier and earlier to try to take advantage of it and stay ahead of everyone else who will likely try to benefit from the news as well.
This has caused much of the anticipated rally in stocks around the holidays to occur earlier and earlier. Nowadays, it isn’t abnormal for the rally to occur in November, before Black Friday, instead of in December.
Part of the under-performance of discretionary stocks is also likely due to the current state of the U.S. economy. Consumers aren’t as confident that the U.S. economy is going to see strong growth in the future, and traders aren’t as confident that the U.S. stock market is going to be able to withstand an interest-rate hike by the Federal Reserve.
The Holiday Lesson
As you can see, there really isn’t any “magic” behind the Santa Claus Rally, but it does remind us to look at important economic forces and evaluate the impact they will most likely have on the market moving forward.
So far, we haven’t seen a strong rally this holiday season, but we have also avoided a sharp decline.
We anticipate that we will see more consolidation on the S&P 500 as we inch closer and closer to next week’s Federal Open Market Committee monetary-policy statement.
InvestorPlace advisers John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next SlingShot Trader trade and get 1 free month today by clicking here.
