Did the ‘Santa Claus Rally’ Come Early?

If you have money in the market, it probably feels like Christmas has come early this year. The S&P 500 is trading at all-time highs, bond yields are rising and the CBOE Volatility Index (VIX) is back down below 12.5. However, this rally wasn’t driven by a jolly, rotund fellow in a red suit who lives at the North Pole. This rally was driven by an outspoken, populist fellow in an Armani suit who lives in New York City.

Did the 'Santa Claus Rally' Come Early?

Donald Trump’s election victory has changed expectations on Wall Street, and stocks have soared as a result. The question now is, with stocks already moving as high as they have, can a Santa Claus rally push them even higher?

Before we answer this question, we have to clear up a few things. First, we’ve got to define what we mean by the “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 next 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 (NYSE).

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.

Next, we’ve got to decide which definition we’re going to use.

With all due respect to Hirsch, we’re going to stick with the new definition of the “Santa Claus Rally” for two reasons. First, we don’t think you 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 seven trading days.

Second, the impact of the economic forces most closely tied with Santa Clause — shopping, shopping and more shopping — is felt on Wall Street before Christmas, not after.

Can Santa Still Rally the Market?

The short answer to this question is … yes.

For the long answer, let’s start by taking a look at the chain reaction that typically leads to a Santa Claus rally on Wall Street.

Retail stocks are often the ignition switch that gets the chain reaction started. Nearly 70% of the gross domestic product in the United States is driven by consumers. If consumers are confident in their financial future, they tend to spend more. If consumers are concerned about their financial future, they tend to spend less.

At no time is this more apparent than during the holiday shopping season. This is the time of year when retailers tend to make the majority of their profits for the year. If consumers show up and spend lots and lots of money to play Santa, retailer stocks tend to rise. This sends a signal to the rest of the market that consumers are confident and that economic growth in the U.S. should be strong. This then leads to other stocks in the market doing well with the expectation of a strong GDP and, voila, a Santa Claus rally.

Watching Retail Stocks for the Santa Claus Rally

So let’s take a look at some retail stocks. To simplify our analysis, we are going to focus on the exchange-traded fund SPDR S&P Retail (ETF) (NYSEARCA:XRT). It covers a broad swath of companies within the retail sector, as you can see in Fig. 1.

Fig. 1 -- SPDR S&P Retail ETF (XRT) Top 10 Holdings

Fig. 1 — SPDR S&P Retail ETF (XRT) Top 10 Holdings

Leading up to the U.S. presidential election, XRT had been an underperformer in the market.

However, in the aftermath of the election, XRT has rallied along with many of the stock market sectors that tend to outperform during economic upswings — like financials, consumer discretionary, technology, basic materials and industrials — while the sectors that tend to underperform during economic upswings — like consumer staples and utilities — have fallen (see Fig. 2).

Fig. 2 -- Stock Sector Rotation Model

Fig. 2 — Stock Sector Rotation Model

You can see this playing out in the comparison chart in Fig. 3.

Fig. 3 -- Stock Sector Comparison Chart

Fig. 3 — Stock Sector Comparison Chart

XRT and the Financial Select Sector SPDR Fund (NYSEARCA:XLF) have been leading the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) higher, while the Utilities SPDR (ETF) (NYSEARCA:XLU) has been moving lower since the election.

As you can see, XRT still has plenty of room to grow before it catches up with the performance of XLF, and a strong holiday-shopping season could provide just the lift the sector needs.

Donald Trump has sparked quite a bullish surge, but Santa Claus has the capacity to keep that surge going. Money continues to rotate out of the bond market and back into stocks as inflation expectations rise on Wall Street and hopes remain high that the U.S. economy will see renewed growth.

Rotations like this tend to take some time, and the bond market is much larger than the stock market, so we should have plenty of fuel for this bullish fire in the foreseeable future.

InvestorPlace advisors 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 trade and get 1 free month today by clicking here.

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Article printed from InvestorPlace Media, https://investorplace.com/2016/11/santa-claus-rally-come-early/.

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