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Trading
"Santa Claus Rally" to bring sharemarket cheer
Jeff Cartridge - December 17, 2007
 With Christmas fast approaching, the seasonal patterns in the stock market suggest that the markets are likely to be stronger into the end of the year. Historically it is very normal for the stock market to rally in December. This rally is known as the Santa Claus rally bringing Christmas cheer to all investors. The recent strong performance of the markets led by the US may be the beginning of this Christmas rally.
Seasonal patterns were first discussed by Larry Williams with reference to commodities. Larry noted that seasonal price fluctuations occurred in agricultural commodities with prices falling when there was an abundant supply, around the harvest times and prices rising when supply was scarce, prior to the next harvest. These seasonal patterns can also be observed in the stock market as supply and demand for shares fluctuates throughout the year.
If we take a look at historical growth of the market measured by the All Ordinaries index over the last 25 years it can be seen that the average growth of the market is 11.1% per annum. But seasonal patterns are not about total growth they are more about when the growth occurs during the year.
The year typically starts well with a small rally through January as investors and traders return to the markets. This bullish trend reverses in February and could be related to final tax payments due in Australia on February 7th. If people are required to find money to pay tax they have less available to invest in the markets at this time. In the US, final tax is due on April 15 and this could account for the stock market saying "sell in May and stay away".
The Australian market however puts February behind it and rallies through March and April before a consolidation in May is followed by falls in June as the financial year rolls to an end. July sees the market bolt out of the gate as new funds are invested by fund managers and superannuation funds that offered attractive tax saving year end deals. This rally continues through August before slowing in September. October has a deservedly bad reputation falling throughout the month and has become famous for the 1987 crash and the 1997 collapse of the Asian economies. A bottom is then formed in November and early December before a strong rally is seen in the final two weeks before the New Year.
While the instability of the financial system, particularly housing in the US suggests a weak end to the year, the seasonal odds certainly favour a rally. In Australia during the last 24 years the Santa Claus rally failed to materialise in just two years 1990 and 1995. The rally in 1999 was weak, but the market was marginally higher in the last two weeks of December. The market has been higher in 92% of the last 24 years and in most cases not just higher, strongly higher. The average return over the last two weeks of December is 3.5%. If this rate of growth was to be sustained throughout the year we would see annual growth of 84% per annum in the markets. Why is it, that Christmas only comes once a year?
While seasonal patterns give a guide to the likely direction, they are not an absolute with seasonal patterns failing to play out as scheduled some years. This could be due to the effect of larger seasonal patterns that may be in play such as the decennial cycle.
Despite recent stock market falls, share investors got off lightly this year. Years that end in "7" e.g. 1987, 1997, have a reputation for poor stock market performance. Utilising US data, because it is readily available over the last 100 years, shows that years ending in "7" have produced negative stock market returns in 9 of the last 10 decades. The only exception to this rule was 1927 and for now, barring any sharp end of year fall, 2007 looks like it may well be added to this list of exceptions.
The strongest year of the decade is a year ending in "5" with the market higher in 11 out of the last 11 decades. While 2005 has been and gone and 2015 is a way off yet there is still good news for investors. Years ending in "8" are the second best performing years of the decade as the market recovers from its falls during the years ended in "7". 2008 is looking good for stock market investors.
While seasonal patterns are not guaranteed to deliver strong profits to investors or traders the patterns do have a high probability of playing out in the future. Not all the reasons for these seasonal tendencies are clear, but it can be very profitable to follow them through all the same. I wish you all Merry Christmas and I trust that Santa Claus delivers you exactly what you want for Christmas. I will certainly be positioned to take advantage of his generosity.
Jeff Cartridge is the author of Supercharge Your Trading with CFDs. For more information go to www.superchargedreturns.com.au. Please note that the views expressed here are those of the author, not of CompareShares. Although all investing has some form of risk, CFD trading strategies are only for experienced traders and risk management strategies must be considered.
More articles from this edition of CompareShares:
Hot stocks: Hot Stocks for 2008
Trading: Santa Claus rally to bring sharemarket cheer
Ethical Investing: Conscientious companies that build wealth
Stocks: Stock of the week - Invocare
Gold: Gold stock ETFs a less risky way to invest in gold
Rates: Interest rate cuts on the way
Expert Panel: Shares - opening price prediction from market depth
Companies: BHP plans slim down after Rio takeover
US markets: US inflation hottest in two years
Whatever your views, you can discuss this article - or any of Jeff's articles - on our message board Your 2 Cents.
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