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  • The S&P 500 has historically gained ground in the last five days of December and the first two days of January.
  • This phenomenon is called the "Santa Claus rally."
  • Losses during this period have historically foretold additional weaknesses.

The Stock Trader’s Almanac has been crunching data to discover market probabilities since the 1960s. Over the years, its research has highlighted important stock market tendencies influencing investors’ behavior, including historical strength in the final trading days of the year and the first days of the New Year.

Specifically, the Stock Trader’s Almanac notes that a post-Christmas rally in the final five days often stretches through the first two days of January, resulting in a so-called “Santa Claus Rally.” The market has returned an average of 1.3% during this period since 1950.

Of course, no one indicator works all the time. If it did, we’d all be rich. The Santa Claus rally has failed to materialize many times, resulting in losses, and when that’s happened, it can be a harbinger of bad times.

For example, the S&P 500 fell 4% in the final days of 1999 and the first few days of 2000, kicking off a terrible stretch for stocks that lasted into late 2002. 

For that reason, the Stock Trader’s Almanac’s founder, Yale Hirsch, coined the phrase, “If Santa Claus should fail to call, bears may come to Broad and Wall.”

So, is a Santa Claus rally likely this year, or will investors have little to cheer to ring in the New Year?

Setting up for an oversold rally

Real Money technical expert Helene Meisler has been charting market activity since the 1980s. One of her most essential indicators is a short-term overbought oversold oscillator reflecting advancing minus declining stocks over a rolling 10-day period.

In “Santa Could Swing by Wall Street, but Won't Live There All Month,” she writes:

“Can we get such a rally? Sure. We are going to be short-term oversold early next week. And quite frankly, that might not line up perfectly with the technical definition time-wise of a Santa rally, but it can come close in terms of timing…The Oscillator is based on the 10-day moving average of net breadth, and you might recall that this Monday will mark two weeks since the market turned south. That means that starting Monday, we will start dropping those negative breadth readings off the Oscillator.”

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This short-term oscillator helped Meisler tilt positive on the market in October and negative into the highs in November. The longer-term oscillator covering 30 days of market breadth won’t yet flash oversold, though.

“This is a far different picture than the intermediate-term oscillator, which you will recall also got overbought right around Thanksgiving. But take a look, and you can see this oscillator, which is based on the 30-day moving average of net breadth, is still far above the zero-line. It isn't even close to an oversold condition.”

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The best scenario is when both oscillators suggest a rally is near. Since the two oscillators aren’t flashing oversold, the short-term indicator may correctly spot a short-term bounce that stalls until the intermediate-term indicator plays catch-up.

Meisler writes:

“The bottom line is that I think, especially if we are down on Friday, we can set up for another short-term oversold rally next week. But since we just got overbought on an intermediate-term basis two weeks ago, it's just a short-term rally.”

Just because we're in a bear market or an inflationary period doesn't mean we can't get a Santa Claus rally. The S&P 500 gained ground in eight of 10 years during the 1970s, a period well-known for inflation. Also, the Santa Claus rally delivered gains in 2000, 2001, 2002, and 2008, despite ravaging bear markets.

The Smart Play

The market tends to rally the week after Christmas, likely because selling pressure from tax-loss harvesting ends. Volume is usually light during the final week because institutional investors often stay home for the holidays. Buyers searching for bargains created by tax-loss selling and investors repositioning themselves for the New Year can move the markets more easily.

This period also coincides with monthly fund inflows tied to retail investors' retirement plan contributions and year-end bonuses. Moreover, it follows quarterly triple-witching options expiration, which can influence investment decisions. In short, real catalysts support the tendency for strength.

If stocks don’t rally, stocks may continue struggling, given the Stock Trader’s Almanac writes, “Santa’s failure tends to precede bear markets, or times when stocks could be purchased at lower prices.”

Because stocks are mired in a bear market, the Fed’s still committed to higher interest rates, and economic activity is decelerating, whether Santa Claus rewards investors with positive returns could be even more important than usual this year. 

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