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Stock markets tend to rally into the year end with what is known as the “Santa Rally”. This year, the rally started in earnest last month, on discovery of a covid vaccine. Further gains are to be expected.

Santa Claus Rally: What is it?

A ‘Santa Claus Rally’ is a tendency for stocks to rise during the final weeks of the year.  Perhaps the year-end rally is driven by a ‘feel good’ factor as everyone celebrates Christmas. As we buy presents for our friends and families, investors also purchase stocks and shares in the festive season.

Historically, the US stocks exhibit this behaviour quite predictably. The Dow Jones Industrials Index, for example, rises in the month of December fifty times out of seventy since 1950.

At the time of writing, the Dow is again flirting with new all-time highs. So, can we look forward to further market gains as Christmas draws closer?

Santa Rally in 2020?

2020 has been a rollercoaster year. The catalyst is the still fast-spreading coronavirus.

Swathes of societies were shut down; industries struggle to operate; while travelling grind to a complete halt. Even Christmas celebrations are now a subdue affair. Pubs and restaurants are struggling amidst a myriad rules of social distancing.

When normal economic activities are suspended, this makes market predictions particularly challenging. Stock market patterns that were observed in the past no longer seem to apply. This includes the Santa Claus Rally.

Until November 9, investors were wary about a quick return to normality. Then suddenly, news of a plausible vaccine arrived. So high was the Pfizer/BioNTech efficacy rate – 90% – that investors cheered and piled into beaten-down travel stocks. British Airways (IAG) soared almost 50% on the news. Carnival Cruise (CCL) jumped almost 45%.

Santa Claus has indeed arrived early bearing gifts of covid-19 vaccines. Because of the Pfizer’s vaccine November 2020 was the strongest month in years. For the Dow, it was the strongest November since 1928 (see below). Other markets reported the same amazing phenomenon.

After such a blistering performance, can we expect a positive December and a Santa Rally?

What happens after a strong November? Some mean reversion.

To put November’s return into perspective, we compare all the November returns for the Dow and rank them.

At 11%, November-2020 was the fourth strongest November in more than a century. Only 1900, 1904 and 1928 beat this year’s. By all account last month was an impressive rally (see below).

Next, I plot the December returns for each of the November return (in red dots, see below) and compare them. This is to observe if any momentum carries over.

The trend is clear. Strong November returns led to some regressions in December. Very few December returns surpassed the previous month.

For example, in 1928 when the Roaring Twenties party was in full swing, the last month of the year was fairly muted, with a price rise of just 2%. In 1904, prices dropped by more than 2.5%.

Thus the US may see a smaller rally in December than the one last month.

What about the UK?

Like the Dow, November 2020 is by far the strongest November in the UK for many decades. Here I used the FTSE 100 Index with data going back to 1984, and ranked all the November months. The result is shown in the chart below.

As for December, the footsie reports 30 positive Decembers out of 37. This is a strong seasonal pattern. Moreover, the strong price moves in November month appears to be drift over into December. For example, in 1989, 1988 and 1999. Positive momentum is observed after a strong November.

As such one can expect December to be a fairly steady month, with the potential of further gains.

However, there is a unique factor impacting the UK market, a factor which is not seen elsewhere: Brexit.

No breakthrough was reported at publication time, despite weeks of negotiations. “We are,” said the German Chancellor on Wednesday, “prepared to go down a path without a trade deal.” When threats of a No-Deal Brexit surfaces, UK asset prices – stocks and Pound Sterling – tend to go down.

Therefore, one needs to be extra vigilant if holding long positions in Sterling assets. The country is heading out of the EU, volatility may spike.

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Party like it’s 1999?

Generally the November-January are the stronger months of the year. The Santa-Rally is followed by the ‘January Effect’. But this year has been such an unusual year that makes these seasonal effects more unpredictable.

For example, the pandemic and the $3-trillion Fed QE triggered a spectacular rally in the tech sector.

Look at the long-term Nasdaq Composite Index below. The 50% rally from March was beyond anyone’s wildest dream. In many ways, this sharp upward acceleration, on top of a multi-year rally, are hallmarks of a potential ‘bubble’.

Last week, the FAAMG (Facebook, Google, Apple, Microsoft, Amazon) commands a combined market cap of $7.3 trillion. Tesla (TSLA) is now worth more than $600 billion, which more than 12 large automakers combined.

When share prices are going in a ‘one-way street’, be careful!

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