Santa Claus Rally

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Santa Claus Rally: A Good Market Indicator, or Should Investors Be Saying Bah-Humbug?

by Dr. Mark Skousen, Chairman, Investment U: Issue #620

As you know, I’m bullish on the stock market right now, just as the Santa Claus rally draws near

The Santa Claus rally usually refers to the week of trading between Christmas and New Year’s. But I like to think of it as the period between Thanksgiving and Christmas Day. And since Santa arrived at the Macy’s Thanksgiving Day Parade on November 23, the Dow has risen almost 5%. So have the Nasdaq and the foreign markets.

Here’s why several analysts are calling a top, and why they’ve got it all wrong

Is It the Santa Claus Rally or the “January Effect”

In many ways, the Santa Claus rally reflects the pushing back of the “January Effect,” which refers to the fact that stocks tend to rise in January, due to:

the end of tax selling;
institutional buying at the beginning of the year; and
funding by pension funds, among other reasons.

But lately, the January Effect has spilled over into the previous year, going back sometimes to October. (Note we hit a new high on the Dow in early October, and the markets have boomed since then.)

Don’t get me wrong. I don’t believe in mindless cyclical and seasonable patterns. As a rational investor, you must always ask yourself, “Why is this happening?”

There may be psychological or fundamental economic reasons for a Santa Claus rally, the January Effect, or the Pre-Election Stock Rally. There are no guarantees in this business. For example, there was no Santa Claus rally in the inflationary period from 1979-81 nor in 1990 after Saddam Hussein invaded Kuwait nor in 2004, when energy prices and Middle East terror woes grounded Santa. But this time?

There have been no major terrorist attacks inflationary pressures are moderating long-term interest rates are falling the Fed is easing and corporate profits are soaring. What’s not to like?

The Santa Claus Rally… My Scrooge Friends Say “Bah, Humbug”

I don’t normally pay much attention to the ranting of my permabear friends who never cease in predicting the imminent collapse of Western Civilization in general, and of Wall Street in particular.

But recently, several intelligent thinkers who have been bullish suddenly turned bearish. Mark Hulbert is one of them

He has been raising red flags lately based on some contrarian indicators. He notes that when investment-newsletter writers get too bullish, or when there are too many mergers and acquisitions, we may be near a top. Both have reached excessive levels, according to Hulbert.

My friend Dennis Slothower, who depends on technical analysis to trade mutual funds, has been bearish all this fall. Ironically, his service is called “On the Money,” but he has somehow missed the mark for months.

Like Hulbert, he points to several technical indicators to suggest that the stock market is overbought and should fall sharply “soon.” It must be driving him crazing to see the Dow hitting new highs almost daily.

The #1 Question You Must Ask Yourself When You’re Wrong

Whenever I’m wrong in my predictions, or investment choices, I always ask myself this question: “What am I missing in my analysis?”

Yet, it’s amazing how many investment gurus fail to address this question, and almost blindly follow their system.

Last week, an old friend called from California to tell me that after years of being bullish on the stock market, he’s now turning bearish. I asked him, “What changed your mind?”

I was surprised by his answer. He said that with falling real estate prices, consumers will have to tighten their belts – and that will cause business to slow down, and perhaps even fall into a recession.

I suspect my friend has been unduly influenced by California real estate patterns. The state’s consumers may be cutting back, but I don’t see consumers nationwide failing to spend.

Moreover, he suffers from a common myth in financial circles, that the consumer drives the economy. In fact, consumer spending is relatively stable, and is likely to increase in 2007. The boom-bust cycle is linked more to the supply side of the economy – business spending and investment – rather than any changes in consumer demand. As CNBC commentator Larry Kudlow recently stated:

“Though not one in a thousand recognizes it, it is business, not consumers, that is the heart of the economy. When businesses produce profitably, they create income-paying jobs, and thus consumers spend.

“ With interest rates falling, I forecast a good year for business spending and capital investment, and that bodes well for the consumer, the economy and the stock market in 2007.

Good trading, AEIOU,

Mark

Today’s Investment U Crib Sheet

Santa aside, the “Pre-Election Stock Rally” could mean substantial profits in 2007 Since 1833, the last two years of each administration (pre-election year and election year) produced a total net market gain of 746%, more than twice the gains of the first two years of these administrations. For details, see Investment U #616: 2007 Economic Forecast: Why “Old Faithful” Will Push Stocks Higher In 2007
A “Midsummer Night’s” rally? Since July 17, the Dow and the S&P are up 16%.
Mark has written extensively on the myth that consumer spending drives the economy. To learn more, see his book, The Power of Economic Thinking.