Will there be a Santa Claus rally this year?

Q: I JUST got my Christmas bonus and I plan to invest it in stocks. I don’t know if this is the right time to invest as the stock market has been falling. Is it a good opportunity to buy stocks now while the market is on vacation? Please advise—Raiza Abadier by e-mail

It looks like investors are still uncertain about the direction of the stock market following the recent failure of the index to rally past beyond the 7,150 resistance.

The heavy selling of shares the past weeks has driven the index back to its historical support at 6,700 level, down by 5 percent from the recent high of 7,084.

Share prices will most probably consolidate at this point before another rally or a break down occurs.

But if you will look at the historical patterns of the stock market performance weeks prior to the onset of holiday season, there is a good chance that the market will stage a Santa Claus rally towards the end of the year.

The selling that we saw these past few days could be a normal market behavior that usually takes place one month prior to Christmas holidays.

A look at the historical performance of the market from Nov. 15 to Dec. 15 for the past six years since 2009 will show that the market fell 83 percent of the time with an average loss of 2.5 percent.

This year, true to the law of averages, the market lost 2.5 percent from 6,909 on Nov. 12 to 6,735 last Friday, Dec. 13. The market could lose some more points but should be able to recover soon if we are to follow historical tendencies.

Why do investors sell during this period? One reason could be due to the belief that institutional investors and traders sell their losing stocks in order to book capital losses as a way to lower taxes by offsetting these against accumulated earnings for the year.

Once the selling is done, the cash raised from the proceeds is then used to buy back shares they sold to begin building their portfolio for next year.

It is during these last five trading days that investors normally start to accumulate, helping share prices go up.

This relatively higher demand for stocks against limited supply of shares caused by absence of big market players who are out on vacation can easily create momentum for stocks to rally by year-end.

The surge in share prices most often extends to first few days in January as more investors come in to take position for the New Year.

A review of the last five trading days of December for the last 29 years since 1985 shows there was a Santa Claus rally 86 percent of the time. The average return after five days was about 2.3 percent.

A closer look at the last 10 years since 2002 also show similar findings where a rally occurred 83 percent of the time and the average return was about 1.64 percent.

In other words, if you start buying now up to Dec. 21, the first day of the last five trading days of this year, you should expect positive returns at the start of the New Year.

The expected actual returns will depend on the volatility of your stock, which can be measured by the beta.

For example, Ayala Land (ALI) has a beta of 1.33. This means that for every 1-percent rise in the PSE index, ALI will go up by 1.33 percent on the average. If you buy this stock at the start of the rally, you would have theoretical returns of 3 percent by the end of the year. This is computed by multiplying the beta of 1.33 with the average return of 2.3 percent.

Historically, January has always been a good month for the stock market.

The Santa Claus rally that started in the last five days of December normally extends up to the end of January the following year.

Based on historical data for the past 29 years, stocks that were bought during the last few days of December end up higher 93 percent of the time with an average return of 3.65 percent.

Following the same example, if you buy ALI this month and hold on to the stock up to the end of January, you would have a theoretical return of 4.85 percent.

This is computed, again, by multiplying the stock’s beta of 1.33 with the average return of 3.65 percent.

While there seems to be strong statistical support that a Santa Claus rally will be coming to town this Christmas, there will always be the probability that historical averages may be violated given the current bearishness of the market.

One factor is the expected interest rate hike by the Fed this week which may cause the market to break down. Although this may have been widely discounted already, the expectations of further increases in rate next year could temper market optimism and may minimize the full benefit of the January effect.

Nevertheless, the current oversold condition of the market offers a lot of opportunities for value investing.

Stocks that are part of the index will be the safest as they are the first ones to recover when the market rallies.

Small caps that have a high correlation with the index, as measured by their high betas, may also be good candidates for trading purposes.

As you take your vacation this holiday season, try to spend some time reviewing your investment strategies this year. Evaluate where you went wrong. Learn from your mistakes and make sure you don’t commit the same mistakes again. Commit to study and improve yourself to become a better investor next year.

Henry Ong is a Registered Financial Planner of RFP Philippines. Stock data and tools provided by Technistock. To learn more about stock analysis and investment, attend the 7th Accredited Financial Analyst (AFA) program starting on Feb 6. To register, e-mail [email protected] or text <name><e-mail> <AFA> at 0917-9689774.