In the realm of finance, the 'Santa Claus Rally' is a concept that ignites enthusiasm and speculation among investors as the year nears its end. This phenomenon alludes to the stock market's inclination to witness an upswing in performance during the concluding weeks of December, frequently peaking around the Christmas holiday. However, this year, several factors might cast doubt on the likelihood of such a rally. But before delving into these considerations, it’s worthwhile to revisit the origins, theories, and historical trends of the Santa Claus Rally.
What do we call the Santa Claus Rally?
The Santa Claus Rally is simply the term used to describe the tendency for the stock market, particularly American indices like the S&P 500, to experience an increase during the week preceding Christmas.
Is the Santa Claus Rally really a thing?
Of course, there is no guarantee that the rally occurs in any one year. Indeed, many argue that the Santa Claus Rally is not a consistent market phenomenon but rather a random anomaly.
For example, an Investopedia article analyzed the S&P 500's performance in the week before December 25 from 2002 to 2021 and found out a relatively flat average return, approximately around +0.385%, for this week. This prompts the question: is the perceived rise potentially driven by investors buying stocks in anticipation of the Santa Claus Rally and aiming to profit from the January effect, another seasonal uptick in stock prices?
Why does a Santa Claus Rally occur?
Examining historical price data reveals a surge in activity, often accompanied by bullish momentum, in the week leading up to Christmas. In contrast, the week following Christmas is seen as relatively calm, with prices meandering in narrow ranges amid thin trading volume.
But what's the reason behind this pattern?
Firstly, many market participants take time off between Christmas and New Year, contributing to reduced activity. Secondly, they tend to adjust their portfolios while liquidity remains high in the period preceding Christmas and show a better picture of their performance to clients and stake-holders. Additionally, year-end reports and tax considerations play a role in shaping market behavior.
As the year concludes, investment professionals shift their focus from active trading to finalizing crucial year-end reports. These reports play a pivotal role in evaluating investment portfolio performance, calculating gains and losses, and determining tax liabilities. Consequently, professionals may prioritize this reporting process in the week following Christmas to ensure accuracy, regulatory compliance, and transparency to clients.
Other theories circulate around the Santa Claus Rally, encompassing the general optimism fostered by the holiday spirit, retail traders directing their holiday bonuses into financial markets, and the notion that institutional investors may be on vacation. This absence potentially leaves control in the hands of retail investors, who tend to display a more optimistic and bullish sentiment.
Exploring risks to year-end market optimism: 6 potential threats to the Santa Claus Rally in 2023
1) Recent strong upward movement in the stock market. Market participants seem to have priced in a pause in the cycle of monetary policy tightening following lower-than-expected inflation figures, particularly in the United States. This has propelled indices higher, nearing their peak levels and reducing the potential for a year-end rally.
2) Geopolitical tensions. Uncertainty and market volatility could increase depending on the evolution of the overall geopolitical scene, especially concerning the war in Ukraine and the conflict between Israel and Hamas. These conflicts also put a strain on the budgets of countries that offer support to some actors of these conflicts.
3) Inflation pressures. Although there are indications of a slowdown in inflation figures across most economies, they remain quite elevated. Central bankers believe that they still need to implement tight monetary policies to address inflationary pressures and ensure that inflation moves towards their 2% target.
4) Monetary policies. Numerous central banks are embracing a "higher for longer" approach to maintain elevated interest rates in their efforts to counter inflation and bring it closer to their 2% target. This implies that these banks are inclined to keep their key interest rates elevated for an extended duration, surpassing the expectations previously held by market participants.
In October, the International Monetary Fund (IMF) International Monetary Fund (IMF) explained that policymakers in advanced economies, on average, have increased rates by approximately 400 basis points since late 2021, while emerging market economies saw an average increase of around 650 basis points. The negative impact of such high rates might worsen soon, as large amounts of corporate debt are due for repayment in 2024 (more than $5.5 trillion).
5) Weaker earnings. As U.S. and worldwide consumers start spending less, with people expecting to cut back on buying due to high interest rates, investors might become more careful and negative towards the end of the year and in 2024.
This change in how investors feel could lessen the usual excitement of the Santa Claus Rally. Investors are indeed worried that higher interest rates could hurt the overall economy and take away the profits that were just starting to improve after the pandemic.
Increased interest rates, reduced liquidity, and less favorable financial conditions indicate potential risks to earnings and valuation multiples, which means that stocks could go down. Many companies worldwide actually issued warning profits during last quarter, such as Beyond Meat Inc., Worldline, Sanofi, Euroapi, Maisons du Monde, Deutsche Pfandbriefbank, and Walgreens among others.
6) Potential slow down in major economies. Although a recession was anticipated in 2023, it hasn't occurred, making investors consider the possibility of it happening in 2024. Lower-than-expected spending in the last quarter of the year increases the risk of an economic slowdown, impacting the overall market sentiment. Investors may also opt to lock in profits from successful positions by selling their trades, adding selling pressure to the market.
According to Barclays's forecasts, global growth could reach 3% in 2023 and 2.4% in 2024 after 3.3% in 2022. In advanced economies, anticipated growth is expected to decrease to 1.5% in 2023 and further to 0.8% in 2024, down from the 2.6% recorded in 2022. Specifically in the US, the growth forecast for 2023 and 2024 is 2.4% and 1%, respectively, following a 1.9% growth in 2022. Conversely, in Europe, the weakness is more pronounced, with a growth forecast of 0.4% in 2023 and a further decline to 0.3% in 2024, compared to the 3.4% growth in the previous year.
The deceleration in the world's most crucial economies is also a matter of concern, reminiscent of the worries observed in China.
With a mere 2% growth in 2023, one of its poorest showings in almost half a century, the Chinese economy faces challenges in recovering from the implications of the zero-Covid policy and the property sector's decline. Comparable to market participants, the Chinese government grapples with mounting worries regarding the nation's ability to sustain growth. The slowdown underscores uncertainties about China's economic trajectory, raising questions about its resilience in the face of external factors and internal challenges, thereby prompting considerations about the sustainability of its growth trajectory.
Amidst this backdrop, the months of October and November witnessed a flurry of announcements, detailing alterations to the national budget over the coming years and the unveiling of a new stimulus package amounting to 1 trillion yuan. This injection of financial stimulus managed to inject a sense of optimism into the markets. However, it's noteworthy that a significant proportion of these allocated funds is not anticipated to be actively deployed until the year 2024 or in subsequent years, thus indicating a strategic and phased approach to economic revitalization.
How to trade the Santa Claus Rally
As we approach the end of 2023, the possibility of a Santa Claus Rally is uncertain due to various factors affecting market sentiment, such as concerns about inflation, geopolitical tensions, and monetary policy paths. Depending solely on the anticipation of a Santa Rally for trading might not therefore be the wisest choice.
Still, if you believe that a Santa Claus Rally will happen, then you can decide to use CFDs on the S&P 500 (USA500) or other indices to profit from the rise. You can also focus on certain sectors or stocks that are most likely to increase during this time, such as the technology sector, the retail sector, and the consumer discretionary sector.
Some investors capitalise on seasonality by investing in well-known holiday-season stocks like Target, Amazon, Etsy, Walmart, Dollar Tree, or Macy's. These blue-chip companies frequently capitalise on the Black Friday and Christmas period to generate profits.
Regardless of your trading strategy, you should always stick to your established trading plan. Implementing robust money and risk management practices is also essential for navigating the inherent uncertainties of the stock market. You should therefore use tools like stop-loss and take-profit orders to effectively manage your overall risk exposure, particularly when engaging in active trading styles such as scalping or day trading.
Furthermore, a key aspect of successful short-term trading is adapting the size of your positions to the prevailing trading environment and market conditions. This flexibility ensures that your approach remains responsive to change, enhancing your ability to make informed decisions and optimise your trading performance
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