The Santa Rally clauses

The ASX cracked 5,400 this week – for the first time in about five years. Confidence in our market is picking up, it seems, and finally, after so many years, we appear to have joined the global equity bull market.

We know the fundamentals and they haven’t changed too much over the last few months – and I doubt they’ll change much over the next few.  

It’s with that in mind that I thought it might be useful to look at the price action going into the Christmas/New Year season (from now to January 31) to see what emerges. I mean, we already know about the well-documented seasonalities over that period – e.g. the ‘Santa Rally’, which tends to hits stocks in December. But I want to extend that a little – and see if there are any other patterns in the price action, at a time when there is less focus on the fundamental side.

In doing so, I’ve chosen the period since 2003 – excluding the influence of the Global Financial Crisis – though not the price action leading up to it. I think this is justified, as the GFC was an extreme event and not representative of what we can expect in a bull market.

First things first, and Santa Rally aside, global equities tend rise about 4-5% (on average) over this period (that is from now till January 31). That’s pretty good for three months’ work, and generally markets have a stronger run over this three-month period than they do for the prior three months. As to the Santa Rally – that is stock prices tend to rise over December – and I don’t really want to go into the history of it, other than to note that since the 1960s the S&P 500 has increased by 1.8% in the month of December (on average). Recent history suggests it’s not just December though.

Anyway, for the major global indices like the S&P 500, this price action has occurred in six of eight years under examination, and in the two it didn’t the US was heading into, or was in, a recession. I like those odds, and so far it appears a good bet that not only will the market continue to push higher, but that gains will likely exceed those of the prior three months (75% of the time). This is great, because the S&P 500 is up about 4.4% in the three months to date. The historical price action suggests that, in the absence of a recession, we can look forward to even stronger gains than that over the next three months.

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For the All Ords, the odds are a little worse. The Christmas period only outperforms the price action for the preceding three months about half of the time. It’s not that the All Ords necessarily does badly – although as you can see from Chart 2 above, it did in 2004, 2010 and 2012. Yet, and including those years, the average gain for this period is still about 4.7%. Considering recent price action, it would be a tough ask for price gains over the next three months to exceed those of the last three given they’ve been so high – about 7%. Especially considering this seasonality only seems to work about half of the time. What’s also interesting is that the All Ords only seems to outperform global benchmarks about half of the time, although looking at it more recently it’s only happened once since the GFC – and that was this year!

On the price action alone, and considering the evidence of seasonalities within that, it would seem that recent calls for Australian investors to go offshore holds some merit – our market’s performance is just too mixed in comparison and global markets are much more consistent in their outperformance. Having said that, I still think the real incentive to go offshore was to be found in 2012 (see my August 2012 piece, Make a Europe splash with Aussie cash). It’s harder now given many markets are pushing records, although it’s true enough to say that just because a market has had a hard run it doesn’t have further to go.

What about those who don’t want to look offshore? Well, as mentioned, our market can perform quite well over this period and the truth is it has only declined in value twice since the GFC. What’s interesting about that is 50% of the time, it’s the mid-caps that tend to outperform over this period, with large caps outperforming three out of eight times, and small caps only once. Considering price action above then, there is some pressure for a mid-cap rally. Not only because it happens half the time as some sort of seasonal trend, but also because this component has underperformed of late, as you can see in Chart 2 below. Large caps, in contrast, have rallied hard.

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Looking at the price action by sector, I couldn’t really discern too much of a trend or much in the way of other patterns. I mean, it’s not like consumer stocks rally in expectation of some huge Christmas spend. Indeed, if there was one pattern to emerge from the price action alone, it is that consumer stocks and perhaps financials are least likely to outperform. Otherwise, info tech had the best record, being the key outperforming sector – and that was 50% of the time.  

Conclusion

If you’re looking to give your portfolio a boost or make any changes over the next few months, then your best bet might be in some of the global indexes.

They have a more consistent seasonality over this period or track record of outperformance – and they tend do better than in the three months prior.  

If you’re not prepared to go abroad, then mid-caps might be the best bet. They outperform 50% of the time anyway, and the fact is our large caps have had a very hard run. They’ve been the ones to lead this rally, and so it’s reasonable to think that investors will start to look for better value elsewhere.