The Santa Claus Rally Has Started: A Quick Primer On What To Expect

It is one of Wall Street's most popular, longest-running conventions: the Santa Claus Rally has become its own self-fulfilling prophecy, leading to 11th hour gains at the end of any given calendar year, and lasting just into the new year even in the absence of good (or as per the New Normal, bad) news.

Courtesy of Oppenheimer's Ari Wald, here is a quick reminder of what it is:

Popularized by the Stock Trader’s Almanac, the Santa Claus Rally (SCR) is the seasonal tendency for equities to rally during the last five trading days of the year through the first two trading days of the New Year.

 

Since 1928, the S&P 500 has averaged a 1.7% gain and traded higher 77% (68 out of 88 years) of the time through this seven-day period, vs. a 0.2% average gain and a 56% success rate during any seven-day period. This year’s “Santa Clock” started December 23rd and ends January 4th.

 

However, performance in the next 1-2 quarters has tended to be below average when the S&P 500 closes lower during the SCR. For instance, the S&P 500 has averaged a 1.3% loss in the subsequent three months following a negative SCR vs. an average 2.8% gain following a positive SCR. Hence the saying, “If Santa should fail to call, bears may come to Broad & Wall.”

Last year’s 2.3% loss marked the fifth time performance during the SCR period was negative over the last 20 years (1999, 2004, 2007, 2014). Following last year’s negative SCR, the S&P dropped 7% in the first month and closed with a modest 1% gain over the full three-month period.

Incidentally, as we pointed out last week, the question with every such Santa Rally is how much of it has been already priced in by the market. This time, the answer may be "all of it", however it may not become apparent for a while because reported, "while the term structure of stock volatility indices presently suggests too much complacency in the market, the risk has typically manifested itself most in the 2 to 3-month period. Therefore, even if that weakness comes to pass, it doesn’t preclude further gains in the longer-term. Nor, by the way, does it preclude a Santa Claus Rally over the next few weeks. However, it does suggest that whatever presents Santa might bring to stock traders may eventually get returned."

This year, however, there may be a glitch: if Credit Suisse is right, and its calculations that a "near record" amount of pension fund selling is imminent as part of a major rebalance are correct, the market is set to stumble as anywhere between $38 billion and $58 billion in US equities will be for sale in the last days of 2016, as we cautioned last week.