There’s an oft-mentioned maxim that tends to be thrown around each year around this time. While it’s easy to dismiss it as a meaningless bromide, this year it has taken on a special significance in light of the recent market decline. As the saying goes, “If Santa Claus should fail to call, bears may come to Broad and Wall.”
That saying was popularized by the renowned market statistician, Yale Hirsch, of Stock Trader’s Almanac fame. In a recent blog post, Jeff Hirsch drew attention to the well-known “Santa Claus Rally” concept developed by his late father.
Many investors tend to conflate the Santa Claus Rally with the seasonal strength that’s typically seen in the last quarter of the year. And while it’s true that the months of November, December and January are historically the best three months of the year, this isn’t actually what comprises the Santa Claus Rally.
As Jeff informs us, the famous rally is specifically the last five trading days of the year, plus the first two days of the New Year. According to Jeff, this year it begins on December 22 and lasts until January 3. He notes that average gains in the S&P 500 over this seven-day trading stretch over the last 55 years are a respectable 1.3%. However, he also warns that:
“Failure to have a Santa Claus Rally (SCR) tends to precede bear markets or times when stocks could be purchased at lower prices later in the year. Down SCRs were followed by flat years in 1994, 2005 and 2015, two nasty bear markets in 2000 and 2008 and a mild bear that ended in February 2016.”
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It’s too early to predict whether or not this year’s SCR will appear, and even Jeff acknowledges anything can happen between now and then. Indeed, in a widely publicized development, the Dow Jones Industrial Average posted its longest consecutive losing streak (10 days to be exact) since 1974 as of December 19. Granted, the Dow was just 6% under its record high at the time—hardly a devastating decline—but the unusual weakness for this time of year understandably raises concerns for some investors.
I have no special insights to offer on what the recent broad market weakness could mean for the coming months. But based on Hirsch’s observations relating to the annual “Santa Claus” effect, if the late December rally fails to materialize, we’ll certainly have reason to enter the New Year with an extra measure of caution.
For those who might be skeptical of the market’s seasonal tendencies and its correlation to the intermediate-term outlook, there’s another useful indicator that merits a close watch as we head toward the end of the year. It’s the relationship between junk bonds and equity prices, with the former tending to lead the latter at pivotal turning points.
Pay Attention to Junk Bonds
As Tom Essaye of Kinsale Trading’s The Sevens Report noted in a recent blog, the bond market is regarded as the “smart market” due to the relative lack of retail investor participation vis-à-vis the equity market, with corporate and government bond trading volumes primarily controlled by institutional participants. He notes:
“Bond traders are required to make decisions with strong conviction focused on the macroeconomic backdrop, including policy rates, inflation trends and growth prospects, with recession risks always in the back of their minds…”
To that end, he notes that a recent show of weakness in the SPDR Bloomberg High Yield Bond ETF (JNK) is worthy of close attention. Already the junk bond ETF has established a lower high in the last couple of months, and Tom believes if it goes on to further make a lower low beneath its recent support near 95.70, “the economic outlook may be dimming, at least in the opinion of the ‘smart market.’” Unfortunately, that’s exactly what happened on December 18 as JNK closed under that level.
Whether or not the latest selling pressure in the high-yield debt market proves to have forecasting value for the early months of 2025 remains to be seen. But if this year’s Santa Claus rally fails to materialize, the added weight of evidence from a weakening junk bond market will suggest that an increased measure of defensiveness will be warranted for investors as we head into what could be a volatile start to the New Year.
In view of the increased potential for turbulence next year, I’ve redoubled my focus on under-the-radar, undervalued stocks with exceptional turnaround potential for the 12 months ahead in the Cabot Turnaround Letter. Nineteen of my last 24 stock sell recommendations in the CTL portfolio produced gains in just the last few months, a record that can be achieved in any investing climate with the judicious selection of catalyst-driven turnaround stocks.
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