Santa Rally or End of Year Sell-off?
The market has the potential to end the year on a high note. But if bears come out to play, it might mean trouble for the market.
Background
Is Santa clause coming to town this year? The ‘Santa Rally’ is a term that describes the five trading days following Christmas as well as the first two trading days of the year. These seven days have historically been risk-on trading environments.
Bullish Case
According to Ari Wald, “since 1928, the S&P 500 has averaged a 1.7% gain and traded higher 78% (70 out of 90 years) of the time through this seven-day period.”
Though, the justification of this rally is not entirely clear. There are a couple of reason why this trade works majority of the time. The end of November and the first half of December are usually led by tax-loss harvesting in which losers in a portfolio are sold in order to offset capital gains tax.
The beaten down stocks that were sold, are then scooped up at bargain prices. Investors who tax-harvested have a 30-day waiting period after the day they sold to buy back those same stocks. If a lot of the tax-harvesting is done beginning of December wouldn’t investors have to wait until the next year press the buy button again?
For the particular stock that was tax-loss harvested, yes. Though, investors will simply just buy a stock that is highly correlated to the stock that they just sold (General Motors & Ford).
When everyone screams fire, everyone runs to the exit at the same time. The market is simply a game of humans following each other in a giant feedback loop.
The Santa Claus rally can be also attributed to thin trading volume due to the holiday seasonality. In return, there is naturally low supply with the year-end tax-loss harvest concluding. Low volume and a lack of selling makes it easy for buyers to institute a rally.
Bearish Case
If the Santa clause rally fails to arrive, it could be a bad sign for stocks. “The S&P 500 has averaged a 1.2% loss in the subsequent three months following [negative returns] versus an average 2.8% gain following a positive Santa Claus rally” according to Wald.
U.S equities saw negative returns in the years 2000, 2004, 2007, 2015, and 2016. The recent spike in omicron cases has caused over 1,000 U.S domestic flights to be canceled due to staffing shortages. This news could be a short-term tailwind for the market. As far as how long the market could take to digest this is uncertain.
Our View
Downside risk on the S&P 500 is limited here with thin volume, limited overall supply, and good seasonality. A “stair climb” into all-time highs is a highly probable outcome.
Buying opportunities are in play as long as /ES stays above 4680. Unless there is real substantial market changing news that the market has not already priced in, a slow market rally next week is on the table.
Technical Breakdown (12/23/21)
NYSE Breadth: 76% upside volume
NASDAQ Breadth: 66% upside volume
On Thursday, we had a decent day of breadth in the market, thanks to the thin volume we saw ahead of the holidays. The markets made their morning move, then trended that way for most of the session.
The main level in the S&P index is 4718 to 4720 on the upside. The downside is 4665, followed by the 10-day and 21-day moving averages.
For the ES, the upside level is 4712. The downside level is the 10-day, followed by the 21-day and 50-day junction.
Our Lean
Total volume was only 801 million shares and S&P futures volume decreased to 1.07 million from 2.6 million a week ago. Yesterday's late rally was a perfect blend of the seasonality with “thin & rally” which we talked about earlier this week.
Our lean is to buy the 20- to 40-handle intra-day pullbacks. If the ES can close above 4730, I think we see 4800+.
Disclaimer: Charts and analysis are for discussion and education purposes only. I am not a financial advisor, do not give financial advice and am not recommending the buying or selling of any security.