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Analytics, 23 December 2021

Will the ‘Santa Claus rally’ occur this year?

The so-called “Santa Claus rally” is a very specific event. Simply defined, it’s the tendency for the market to rise in the last five trading days of the current year and the first two days of the new year. The rally has produced positive returns 34 of the past 45 years for an average return of 1.4%. If Santa does not come, it could portend a bear market.

Will the Santa Claus rally occur this year? The seasonal stock market phenomenon historically started this week and will continue into the first days of the new year. But the dynamics are different. This year the market is dealing with the omicron variant and a Federal Reserve intent on withdrawing liquidity and beginning rate hikes sometime next year.

Omicron is key to the bull narrative

The emergence of the Omicron variant has caused some investors to shift the mix of stocks they own, but the overall effect is still very modest. Since Federal Reserve adopted a more aggressive stance to combat inflation around Nov. 30, defensive sectors like health care and consumer staples have outperformed, while cyclical sectors like industrials, energy, and banks have slightly underperformed.

Meanwhile, technology — which is the largest sector in the S&P 500, is flat because some of the largest stocks (particularly Apple) have done well. But when you look past the largest names in technology, you will notice there is a selling trend, particularly in the more speculative tech stocks.

Since November close, the S&P Technology sector has risen 0.8%, semiconductors fell .9% while the software sector is down 6.2%.

Indeed, while the uncertainty around the omicron has battered the bull narrative, it is still the dominant narrative on the Street. Wall Street analysts agree that the omicron is highly contagious but for those fully vaccinated with a booster, it is not as dangerous. Thus, there will be no mass shutdowns of the economy. The expectation is that the bottlenecks/supply chain issues will ease in the first half of 2022, and this will make the Fed will be less aggressive on inflation. Similarly, the consumer remains strong.

The market gained throughout the trading session, overcoming fears about the Omicron COVID-19 variant, and was pushed upward by improving consumer confidence and gross domestic product growth. The positive swing continued Tuesday’s trend when stocks recouped losses.

This combination — a strong consumer and economy, coupled with a Fed that is raising rates slowly and gradually — means the market should hold up in 2022.

Inflation Data is key

The bear narrative, of course, is that omicron will lead to more persistent inflation issues. Bulls have been keeping a close eye on one of the final data points for the week — Thursday’s release of the November Personal Consumption Expenditure (PCE) deflator, the Fed’s preferred tool for examining inflation.

The PCE deflator gained 5.7% from the prior year, which is in line with consensus estimates from FactSet. Core PCE, which excludes food and energy costs, came in slightly hotter than expected, rising 4.7% year over year. Consensus estimates from FactSet called for an increase of 4.6%. Economists expect inflation to peak here in Q4 and for the next several quarters.

Santa Claus rally will very much occur

According to the Stock Trader’s Almanac, it takes place over the last five trading days of December and the first two sessions of January. Santa no-shows on Wall Street tend to precede rough periods for stocks. The Stock Trader’s Almanac discovered this trend in 1972.

The ultimate hope is that the markets remain choppy in the next few days but rallies going into the close of the year. The bulls expect the market to close the year at historic highs. That would not be a stretch: The old closing high of 4,712 on Dec. 10 is only 16 points away. Meanwhile, January has been a historically strong month for the stock market, informing the old Wall Street adage, “As goes January, so goes the year.

If you are waiting to reap from the Santa Claus rally, the advice is that you should not wait until the end of the year - you have to weigh the probabilities, and the probabilities are we should not fear the Fed because omicron is not going to exacerbate the supply chain shortages.

The bulls’ final piece of ammunition: During the month of December, the S&P 500 tends to peak during the last week or even the last day of the month. Since 1980, the S&P’s December high happened during the last week of this month in almost half (41 pct) of years.

Thus, the Bottom line: History says the S&P will likely hit another record high later this month.

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