If you're holding out for a Santa Claus rally this year, you're not the only one. After stocks rallied through October and November, December has been a brutal month thus far.
The Fed rate hike last week and its forecast for higher interest rates spoiled investor hopes for a pivot in monetary policy. As you can see from the chart below, most of this month's sell-off has come since the rate-hike decision.
With just a few days left in the year, the stock market is basically assured of finishing deep in negative territory for 2022. History has shown, though, that more often than not, the stock market has rallied at the end of the year in what's come to be known as the Santa Claus rally. While it might seem like an idle phrase, it actually has a specific definition and was first noticed by Yale Hirsch, author of the Stock Trader's Almanac in 1972.
The Santa Claus rally is defined as the S&P 500's general pattern of gaining in the last five trading days of the year and the first two trading days of the next year. This period will begin on Dec. 23, 2022 and go until Jan. 4, 2023.
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Will we get a Santa Claus rally?
Prognosticators are generally pessimistic about the prospect of a Santa Claus rally this year, given the market malaise over rising interest rates, weak November retail sales, and low expectations for the holiday season. Based on recent history, however, it seems more likely than not that we will get a Santa Claus rally.
It might surprise you, but during the last two years when the S&P 500 fell -- in 2008 and 2018 -- stocks did rally over the end-of-the-year period, despite the downward trend coming in. In the 2018 rally, stocks jumped 4.1% over the seven-day period and continued gaining from there, as the market bottomed on Dec. 24, 2018 after a three-month slide that just missed entering a bear market.
Meanwhile, in 2008, the S&P 500 soared 7.5% during the Santa Claus rally in what turned out to be a bear market rally during the financial crisis, as stocks would plunge for another two months before bottoming out in March.
There's something else noteworthy about the Santa Claus rallies in each of those years. Hirsch also noticed that there was a predictive correlation between the Santa Claus rally and the market's performance over the next year, especially if stocks also gained in the first five days of January and in the whole month of January, which he called the January Barometer.
In both 2008 and 2018, the Santa Claus rallies portended strong gains in the market the following year, as the S&P 500 gained 23% in 2009 and 29% in 2018.
What it means for investors
The Santa Claus rallies of 2008 and 2018 should offer some encouragement to investors this year. But there's no causal relationship between bear markets and Santa Claus rallies, and there's no guarantee that the market will gain in the year following a Santa Claus rally, though it has happened 18 of the last 23 times stocks have gained during the seven-day period.
If we do get a Santa Claus rally, it seems unlikely to mark the market bottom as it did in 2018, as investors are still nervous about a recession and future rate hikes from the Fed. However, a rally would help boost optimism going into the next year.
Ultimately, investors are best off if they focus on buying high-quality stocks at fair prices. If history repeats itself, however, a Santa Claus rally could mean the start of a new bull market in 2023.
