Seasonality Is Bullish? What Could Possibly Go Wrong?

By Lawrence G. McMillan

While we’re on the subject of seasonality, let’s review what happened over the past two years, because the seasonality did not remain bullish throughout the “usual” period.  The “usual” period is that the market rises from the day before Thanksgiving through the second trading day of the next year.  There are really three seasonal patterns that comprise that entire time frame: a) the post-Thanksgiving bullishness, b) the “January effect,” which now takes place in December and has for many years, and c) the “Santa Claus rally.”  

The “Santa Claus rally” trading system says that the market should rise over the last five trading days of one year and the first two trading days of the next.  If the “Santa Claus rally” does not occur, though, it can be a negative signal for stocks.  The inventor of the “Santa Claus rally” system, Yale Hirsch, said “If Santa Claus should fail to call, Bears may come to Broad and Wall.” 

In both of the last two years, the “Santa Claus rally” failed, and the broad stock market sold off sharply in January.   Taking the statistics from the 2017 edition of The Stock Trader’s Almanac, we see that $SPX lost 3.0% and 2.3%, respectively, in 2014 and 2015.  Even so, before that there was a rally into the Christmas holiday.  Figure 6 shows a two-year chart of $SPX.  On it, you can see that there was a rally into Christmas (encompassing the latter half of December at least) – as shown by the blue lines -- but then the Santa Claus rally failed, as shown by the red lines.  After both of those failures, the month of January saw severe selling – producing losing months for both January 2015 and January 2016 (both of which belie the “January Barometer” theory that “As goes January, so goes the year” – but that’s a subject for another time).  

So, expect the seasonality to work into Christmas.  After that, there’s a chance that the “Santa Claus rally” could fail again, although it has never failed three years in a row!

One final note: The Chartist Newsletter, published by Dan Sullivan and Steve Mais (www.thechartist.com)  has researched these statistics: the Dow’s rise in the five weeks since the election (+8%) is the largest 5-week, post-election rally in history.  In the previous five times that the Dow has risen at least 5% in the post-election period, it continued on strongly (average gain: 10% over the ensuing six months) in four of the five instances.  The only one was after the second Eisenhower election.

This article was published as part of The Option Strategist Newsletter on 12/16/16. Receive immediate access to all articles by subscribing today.