As we approach the end of yet another year, the year-end rally often takes the center stage. This is the time when investors and market players make strategic moves.
Traditionally, several factors contribute to the rally, one of which is portfolio rebalancing. As the year concludes, institutional investors and fund managers often adjust the weightings of their assets through a process of buying and selling of stocks, which positively impacts its prices.
This is also the season when fund managers often participate in “window dressing” their portfolios, which involves showcasing high-performing assets to create an attractive year-end report to clients and promote their funds.
On the other hand, some investors engage in tax-loss harvesting, which involves selling underperforming stocks to offset their capital gains. This strategy creates selling pressure earlier in the year and opens up potential buying opportunities during the last days as investors seek to reinvest.
During this holiday break, trading volumes typically decrease as many market participants take their time off, leading to lower liquidity. This, in turn, can amplify market movements and contribute to higher stock prices.
Historically, the stock market tends to rally in the last five trading days of the year, which usually spills over into the first two weeks of the new year.
Historical patterns
If we look back over the past 38 years since 1985, the Philippine Stock Exchange (PSE) index has consistently closed the year on a positive note in 76.3 percent of instances, with an average gain of 2.8 percent. This positive momentum often extends into the first two weeks of January, resulting in an additional average return of 3.3 percent.
In other words, if you buy one day before the five-day countdown begins, which, in this case, is on Dec.21, you could potentially achieve a total return of 6.1 percent by holding your investments until the tenth trading day of January 2024.
Last year, consistent with the Santa Claus theory, the PSE Index closed higher on the last five trading days of 2022 by 1 percent. As expected, this positive trend continued into the first ten trading days of January, resulting in an additional gain of 7.3 percent for a total return of 8.3 percent.
While this recurring phenomenon appears to be a reliable market behavior, it is essential to note that historical patterns are not foolproof predictors, and market dynamics can evolve. The potential strength of a year-end rally is often intertwined with market sentiment.
The probability of a Santa Claus rally over the years has been declining. In 2013, the likelihood was high at 86 percent, based on its historical performance since 1985. However, this probability gradually decreased to 81 percent in 2017 and further to 79 percent by 2019. This year, the probability dips even lower to 76.3 percent.
The other way to look at it is to examine the occurrence of a Santa Claus rally over a more recent timeframe, focusing on its performance from the past five years.
Before the onset of the pandemic in 2020, the probability of a Santa Claus rally had consistently stood at 80 percent since 2016. However, during the challenges of 2020, this probability declined to three out of five years, or 60 percent. By 2021, it sank even lower to 40 percent—a trend that persisted through 2022.
Maintain balanced perspective
Following this historical trend, the likelihood of a Santa Claus rally occurring this month seems relatively slim, given the current prevailing negative market sentiment. Even if one were to materialize, it could potentially be a weak rally stemming from a substantial sell-off in the market.
In the quest to forecast a Santa Claus rally for the year-end of 2023, one must weigh historical patterns against current market realities. While the historical prevalence of such rallies suggests a positive outlook, the ever-evolving nature of financial markets, including the global landscape and social mood, demands a comprehensive analysis of multiple factors.
As the year draws to a close, it’s important to stay vigilant and acknowledge potential risks. External shocks, unexpected economic downturns, or adverse geopolitical events can disrupt any anticipated rally.
Maintaining a balanced perspective and being prepared for unforeseen challenges is essential. As the holiday season approaches, let us take our well-deserved break. It is an opportune time to reflect on this year’s investments, evaluate our past decisions, learn from our mistakes and use these insights to become better investors next year. INQ