Is the Santa Claus Rally Real?

As of the close on December 18th, the Dow Jones Industrial Average, the S&P 500 and the Nasdaq Composite were all slightly lower for 2018. We came into the fourth quarter with the markets at their highs, consumer spending was expected to be robust (and has been) and all seemed well. However, it’s been anything but rosy since. Stocks have been hammered over the past 10 weeks and with just a few trading days left in the year, investors are hoping for a Santa Claus rally to save the year.

But will it come?

That largely depends on the role that the Federal Reserve wants to play this year. Will Chairman Jerome Powell be handing out candy or coal when the group makes its interest rate decision on December 19th? At this point, the market’s reaction is almost totally dependent on what the Fed does.

We are essentially staring down four main choices, which include:

  1. Raise rates this month, go into wait-and-see mode for 2019 (dovish)
  2. Don’t raise rates this month, go into wait-and-see mode for 2019 (very dovish)
  3. Raise rates this month, remain on same 2019 rate-hiking schedule (very hawkish)
  4. Don’t raise rates this month, remain on same 2019 rate-hiking schedule (hawkish)

Based on recent commentary from the Fed, it seems clear they don’t want to push the economy into a recession. It’s also clear the Fed misjudged its aggressive rate-hiking agenda from earlier this year, putting it in a tough spot now. 

So what does Jerome Powell and the Fed have to do with a possible Santa Claus rally?

The two parties have everything to do with it! A popular saying on Wall Street is to buy into the Santa Claus rally, although depending on who you ask, the timing can be quite different. Some consider it the last week of the year — a gift to investors left after a visit from the big man. Some consider it a gift leading up to Christmas, so generally the stretch from Thanksgiving to Christmas. Some simply think of it as the month of December.

But is it real?

Defining the Santa Claus Rally

Officially, most consider the Santa Claus as the last week of December through the first two trading days of the new year — and yes, it’s real.

Given that Christmas Day and New Year’s Day are exactly a week apart, this leaves many investors, fund managers and traders out of the office and on vacation. This results in light trading volume and let’s the stock market drift in whichever direction it desires. Regarding this period specifically, that direction tends to be higher. Since 1969, this stretch of time has rallied 75% of the time (34 of 45 times) and has gained an average of 1.4%.

Some may wonder if that makes this market a screaming buy. It in fact, does not. For starters, an average return of 1.4% is far from special. Sure, that’s pretty good for one week of work, and if we were in a raging bull market with low volatility, investors would have the green light. But in a market under tremendous pressure and full of volatility, the last thing many want to do is bet the farm on a 140 basis point rally during a low-volume trading week.

Admittedly, this is just an “average” and the market can easily outperform or underperform that figure in any given year. For instance, the S&P 500 could fall 3% that week or rally 3%. We just don’t know for sure.

Widening our scope even more, we found that December is actually the market’s best month. Its average return dating back to 1950 is 1.6%, besting the 1.5% average returns in November and April. That said, look at how the indices have done this month. We can’t always bank on a strong December. 

Santa’s Bottom Line

So all in all, what are we looking at?

The fact of the matter is that the Santa Claus rally is as real as they come. But that doesn’t mean we should expect it every year without fail. Ultimately the market comes down to a number of factors, and seasonality plays just a small role.

Whether we get our year-end rally this year may very well come down to the Fed. If Powell & Company give investors the news they’re looking for, they could bid stocks higher into the holiday-shortened week and allow them to drift higher into 2019. If the Fed disappoints, we may see more weakness into year-end.

Let’s see if we get Rudolf or the Grinch this year.