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Seasonality is one of those things many investors take for granted. And right now, two of the biggest seasonal trends are bearing down on the market.
At least, in theory.
First, there's the so-called "Santa Claus Rally," a period of strength in December. Some credit increased activity as institutional investors trying to juice returns before year-end, and others think it's just the happiness of the season giving Wall Street a lift.
Soon after comes the "January Effect" that lifts stocks briefly to start a new year. Possible culprits here include investors entering the market with fresh year-end bonuses or other windfalls, or those who sold stocks in December for tax reasons re-entering the market in earnest.
But do either of these supposedly annual trends really hold up under scrutiny?
And more importantly, does either seasonal rally have a chance of materializing in the next several weeks?
I think they do — particularly the short-term prospects of a big rally across the month of December.
Let's take a closer look at both seasonal trends and their outlook:
According to the Stock Trader's Almanac, there is good precedent for being bullish in December. The publication notes that this month is the best of the bunch; December boasts the biggest month of returns for the S&P 500 (.SPX) since 1950, averaging 1.7% gains.
And in the last 63 years since 1950, there have only been 16 Decembers that haven't resulted in gains for the S&P 500 — an incredible 74% winning percentage.
And if, like me, you think more recent data from the era of electronic trading matters most, the stats are even more compelling: Since 1970, the S&P is 35 of 43 in December. That's gains 81% of the time.
Equally powerful is the record of the S&P in December when the market is having an up year. The S&P is has recorded an annual gain in 48 of the last 63 years. And in those 48 winning years, 37 have seen gains in December — a 77% rate.
More recently, since 1980 there have been 26 out of 33 years in the money. And of those 26 years, December has finished with a gain in 19 of them — a 73% rate.
And keep in mind that even when the market does tend to stall out in December, it doesn't crash and burn. Only three of those 16 down Decembers since 1950 saw a decline of more than 2.8% — a loss of 4.1% in 1957, a dip of 4.2% in 1968 and a nearly 6.0% drop in 2002 in the final stage of the dot-com collapse.
The historical data tells a pretty substantial story about the strength of December, then. But what about December 2013, specifically?
Well, stocks undoubtedly have the wind at their back as the major indexes continue to set new highs and as fears of Federal Reserve "tapering" have taken a back seat after comforting words from Ben Bernanke and his successor as Fed chief, Janet Yellen. Furthermore, jobless claims continue to come in better than expected and recently hit a two-month low and housing prices are tracking the biggest annual increase in seven years.
It's hard to imagine the narrative changing in the next few weeks — particularly since there isn't going to be a lot of news from policymakers or corporations in late December.
Furthermore, the market's roughly 3% rally in November has made chart-watchers pretty happy — putting the index above its 20-day, 50-day and 100-day averages.
Add it all up and it seems that the Santa Claus rally in December is a very likely scenario.
Market historians credit the "discovery" of the January Effect to investment banker Sidney B. Wachtel, who was one of the first investors to examine seasonality in earnest in 1942.
And while much has changed in the intervening years, the strength of January seems to be a trend that has endured.
Of the 64 Januarys since 1950, 39 have finished with positive returns. That's more than 60% of the time. And the 34 most recent years, spanning from 1980 through January 2013, show 22 winning Januaries — a 64% win rate.
The average returns are pretty good, too. The month of January has delivered an average gain of 1.6% since 1950, making it the second-best month behind December. More recently, the gains are even more impressive with 2.0% returns since 1980 in the month of January.
So forget the past — how about this year?
Well, it's hard enough to plot a path for the market in the next 30 days let alone the next 60 so I'm less confident about January than December. A lot can change in two months, and we are going to get a host of important data after the New Year's break including data about holiday shopping, the beginning of the fourth-quarter earnings season and other macro news that could move the market.
But as 2013 has shown us, handwringing about the risks of a downturn only mean you miss out on the next leg up. If you think fear of some unforeseen and unknown problem is a legitimate reason to stay out of the market, frankly you'd never have a reason to get it.
Barring any unforeseen trouble, then, investors can expect the momentum that is likely in December to carry on into the New Year — both because of historical trends and because of the bright short-term outlook for stocks at this moment. Consider that 2013 inflows to stock-focused funds will be the largest since 2000 when the tech bubble burst, and that nearly every measure of investor sentiment is handily bullish.
It will take a lot to knock that trend down, especially considering that December is normally a great month in any year and a strong finish to 2013 will only bolster optimism.
Of course, past performance is never a guarantee of future returns. And Wall Street could change its attitude in a hurry should we get a particularly bad piece of news — geopolitical tensions in the Middle East boiling over, a trading glitch rattling confidence or any other number of unpredictable headlines that change the game.
But given the data and the big run so far in 2013, betting on a decline in the next two months just because we are "due" seems to be the wrong move.
Even if the charts and sentiment weren't pointed higher, history is on investors' side in December and January.
That's a pretty compelling reason to trust in a rally across this December and January.
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