Should we expect a Santa Claus rally this Christmas?

Almost the same time last year, the PSE index was struggling to stay above the 6,700 support. At that time, the market has been declining for months losing about 17 percent from its all-time high of 8,134 in April of 2015.

This year, the market found itself in a similar situation trying to stay alive beyond the 6,700 support. The PSE index also has been falling for months since achieving its 52-week high of 8,114 last July.

Interestingly, total market losses from thereon also accumulated to 17 percent at current market level.

Despite uncertainties in the market, especially with the recent sell-offs this week, share prices will most probably take a break at this point before the market resumes its decline or stages a rally.

Will the market ever recover before the year ends?

If we will follow the historical behavior of the stock market during the holiday season, there is a good reason to believe that the market may stage a Santa Claus rally during the last five trading days of the year starting tomorrow.

Based on historical data for the last 30 years since 1985, the market has always rallied during the last five trading days of December in about 81 percent of the time. The average returns gained from this run-up was about 2.23 percent.

A closer look over the last 10 years since 2006 also shows similar findings where a rally occurred 70 percent of the time and the average return was about 1.3 percent.

In December last year, the market rallied at the start of the last five trading days and closed higher by 1.23 percent by the end of the year.

If you start buying today, there is high probability that your portfolio will earn positive returns at the start of the New Year.

January effect

What is more interesting is that the Santa Claus rally always extends to the first two days of January in about 90 percent of the time based on historical data for the past 30 years. The average return for the whole seven days was about 3.3 percent.

Again, looking closer over the last 10 years also shows the same pattern where the Santa Claus rally has extended to the first two days of January in 90 percent of the time at average returns of 2 percent.

What will make this possible?

Declining volume over the past few weeks as the market declined could indicate that the selling rampage may soon be over.

Most of the institutional investors and traders who have sold their positions to re-balance their portfolio and booked their losses for the year must have already raised some cash to start rebuilding their investment positions for next year.

Current oversold condition of the market offers golden opportunity to bargain for undervalued stocks. If you want to take advantage of the rally, buy stocks with high beta.

Ayala Land (ALI), for example, has beta of 1.36. This means that for every 1 percent increase in the market, the stock will go up by 1.36 percent. If the historical return is 3.3 percent, then the expected gain from ALI is 4.5 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 a chance that historical averages may be violated given the current bearishness of the market.