Santa Claus Rally: Is a Year-End Stock Recovery Coming to Town?

By Dr. Mark Skousen, Chairman, Investment U
Monday, November 28, 2005: Issue #490

Now that we are in the holiday season, you will be hearing more about the so-called “Santa Claus Rally.” It is a well-known phenomenon, first discovered by Yale Hirsch and published in his Stock Trader’s Almanac. During this year-end rally, stocks tend to advance, sometimes sharply, from the day after Christmas to the first two days after New Year’s Day.

But now, just as the retailers have extended the Christmas shopping season to Halloween, the Santa Claus Rally has been extended by traders to cover the final two to three months of the year.

At Investment U, we want to answer three questions:

• Is the Santa Claus Rally real? Can it be confirmed historically?
• What is the cause of this year-end stock rally?
• Most importantly, will we see a Santa Claus Rally this December?

I’ve done a great deal of research on this topic, and here are my answers…

Stocks Tend to Rally at Year’s End

First, is the Santa Claus Rally historically factual? The answer is yes. In terms of the original Santa Claus Rally, 65% of the time (going back 100 years), stocks have advanced during the week following Christmas Day, and have done better than December as a whole.

In the past eight years, November and December have been extremely bullish. Even during the bear markets, 2000-2003, stocks rallied in the final two months. See the chart below of the Dow Jones Industrial Average, and notice the steep run-ups just before the annual vertical lines.

Year-End Money Flow Boosts Stocks

Analysts suggest several factors that drive the Santa Claus Rally:

• The end of tax-loss selling.
• A tendency for investors to fund IRAs and 401(k)s at the start of a new year.
• Financial institutions and mutual funds seeking to be fully invested for the New Year.
• Upbeat year-end stock forecasts for a good January (the January Effect).

Five Reasons for the Santa Claus Rally

So, will we see a Santa Claus this year? Since October 1, the Dow is already up 7%, and the Nasdaq 100 is up 15%. Here are five good reasons why I believe we could see a continuation of this stock rally:

1. The Fed may postpone raising rates. According to the minutes of the most recent meeting, November 1, some board members oppose further hikes in the Fed Funds Target Rate. Pressure is mounting for the Fed to ease, especially with gas and oil prices down from their highs in September.

2. The Fed is pumping new liquidity into the banking system. M2, the broadest definition of the money supply, is now growing at a 7% rate, the fastest this year.

3. Corporate earnings are strong.

4. CPI inflation is likely to ease, following a sharp drop in gasoline prices.

5. Long-term interest rates have fallen back under 4.5%.

In sum, it’s time to stuff your Christmas stocking with stocks and join the holiday merriment.

Good trading, AEIOU,

Mark

Today’s Investment U Cribsheet

• Take a quick look back at Investment U # 481, How to Profit From Ben Bernanke and a Volatile Federal Reserve, for an overview of the Federal Funds rate in the Greenspan era, as Ben Bernanke prepares to take over the helm.
• With year-end stock rallies on our minds, stop by Forecasts & Strategies and take a look at my December Checklist for some crucial actions to take before 2006.
• Only Three Days Left to Cast Your Vote for the 2005 Benny Award! The winner will receive $10,000 to make a charitable donation. IU issue #486 has all the details on Investment U’s new annual award. Let us know who YOU think deserves to win by responding to editor @ www.investmentu.com before December 1. We’ll announce this year’s winner in February.

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