By Stephen Pope, Managing Partner of Spotlight Ideas
- Even if by “patch-work”, US will avoid the cliff.
- From 1981 to 2011, 75% of December trade has been higher in US equity indices.
- Do not bet against the evidence.
Of all the equity markets in the developed world, the most closely followed are those of the Dow and the Standard & Poor’s 500 in the United States. This is especially true this year as we have to contend with the worries of the “Fiscal Cliff”. In that regard it would appear that whenever there is a snippet of bad news the markets fall and vice-versa.
Of course we do not seek to make light of the fiscal cliff, for as our paper of November 10th 2012 “Keep Away From the Edge!” showed as President Obama blends the end of his first term into the beginning of a second this will be the most talked about issue. It should harness the attention of all who serve as elected officials in DC as this is when the Budget Control Act of 2011 is scheduled for implementation. As 2012 yields to 2013 there are a number of legal alterations in the US that are scheduled to come into effect. These include:
• An end of the 2011 temporary payroll tax cuts A 2% tax increase for workers.
• An end of certain tax breaks for businesses.
• Alterations upwards in the alternative minimum tax, i.e. a tax increase.
• The end of the “W” tax cuts from 2001-2003.
• The start of taxes related to President Obama’s health care law, “Obamacare”.
• Spending cuts agreed in the debt ceiling deal of 2011 are activated.
The simple and most widely touted estimates are that if implemented in full, the impact will see USD600Bn or 5% sucked out of US GDP so plunging the economy back into recession. (Please see the mentioned paper from November 10th for a more rigorous working of the numbers).
Christmas Comes But Once A Year
Now we cannot control what the American elected elite will do, but we can place a little faith in the fact that politicians the world over love to posture and pose and then as the deadline draws near they tend to find a way to avoid the greatest calamity. One only has to look at the shenanigans in the Eurozone over the past 3 years to recognise how true that is. So we expect a turbulent time, but we sense that the momentum will gravitate toward a settlement that at least prevents the US economy from heading into a new economic ice age come January 1st 2013.
We have analysed the Dow Jones Industrials Index (DJII) and the Standard & Poor’s 500 Index (S&P500) for the percentage gains or losses across the month of December from 1981 through to 2011. Over those three decades Wall Street has shown a gain in three quarters of the Decembers (71% on the Dow Jones and 77% of the time on the S&P).
December is then, over the past 31 year in general a profitable month for investments in US equities. This is not just a random quirk of the markets as we can run a statistical analysis over the returns to further illustrate the bias to positive returns in December.
Figure 1: Detail of DJII December Performance 1981 – 2011
Source: NYSE, Spotlight Ideas
Figure 2: Detail of S&P 500 December Performance 1981 – 2011
Source: NYSE, Spotlight Ideas
The two key US indices have clearly demonstrated a tendency to rise in December and so with remarkable
regularity the gains create the so called “Santa Claus Rally”. We can identify three distinct reasons for the boost
in equity index values:
1. Window Dressing:
For fund managers, booking a good return at the end of a week, month, quarter and especially a year is essential to the evaluations of their funds or assets under management (AUM) will be regarded. It can have a great impact not only on the remuneration they will receive but also on new funds that are assigned to them for the following year. Many fund managers spruce up the portfolios ahead of year-end and hunt for bargains or increasing positions in winning investments.
2 .Q4 Seasonality:
December caps off Q4 and investment dealers frequently release upbeat, bullish annual outlooks. We start to
gather data from Black Friday onward and it generally reveals an uptick in consumer spending which will act as
a boost to top line growth. Given that since 2007 operating costs have been trimmed and made more efficient
we tend to see a real pass through to the corporate bottom line. Funds may see a greater inflow to AUM as bonus payments and bond interest payments provide investors with more cash to put into the equity market. The “Santa Claus Rally” is the strongest three week period of the year for the US equity market, with an average return of roughly 1.70% over the past 31 years. Now as our earlier data has shown clearly not every year is profitable, but almost three quarters are. A seasonal trend is worth investing in if it’s profitable more than 50% of the time; better still if that is the case over 70%. Both the DJII and S&P 500 meet that criterion.
3. Christmas Cheer:
If one studies the indices in detail over the past 31 December’s it will be seen that the majority of the gains are
booked in the second half of the month. Given the final week is foreshortened because of the holidays and because volume tends to be somewhat thinner.
Traditionally the Santa Claus Rally starts in October, but this year it is slightly out of sync as the US markets
waited until mid-November before starting to rise; clearly the apparent tightness in the US Presidential election
was keeping cash piles on the side-lines. In the end, election was not as tight as expected and the prospect of Ben Bernanke staying in post as Fed Chairman has been helpful to the equity market outlook even if the DC debate is not.
Figure 3: DJII & S&P 500 Slip From September 14th. Rise Starts November 16th
Source: NYSE, Spotlight Ideas
In December it is common to see the trading volume fade as Christmas approaches and in such thin markets the prospects of finding an aggressive market bid are rare, with the exception of a sudden and unexpected piece of breaking news. This has a tendency to be conducive to allow markets to rise on relatively thin volumes.
Of course we do need to see some better rhetoric on the “Fiscal Cliff”, but as said at the start of this paper we do not expect DC to plunge the economy into recession. Any deal will provide a boost to allow equities to build on the gains since mid-November. That will allow riskier assets to make a decent run through December into January 2013. Why we may even catch a tail wind from more aggressive Fed driven QE.
There have been calls higher for US GDP from several investment banks, up from 1.4% to 1.85% given the gain
in Durable Goods Orders which came in ahead of expectations in October. Manufacturing in the Richmond
region rebounded in November and the Case-Schiller index of house prices was up 0.4% in September. Plus going into the festive season when we want consumers to spend the Conference Board reported its consumer confidence index hits its highest mark since February 2008.
Do not forget that finished inventory levels are now at their lowest level since the current growth slowdown started; if consumers keep spending, eventually there will be a need to replenish their warehouses.
The US indices are now finally enjoying a degree of relative strength and hedge funds, based on the latest data
from the Commodity Futures Trading Commission, are covering their net short positioning against equities and
taking a new long stance. This is reflected in the options market where market breadth is improving, and cyclical economically-sensitive stocks are leading the way higher.
Figure 4: Technical Perspective of DJII in 2012
Source: NYSE, Technical Analysis, Spotlight Ideas
In 2012, Christmas Day will fall on Tuesday and the option expiry will have occurred in the previous week. In the US market there will be 17 trading days from 11th December until January 4th …given the history has been
for a strong period of gains at this time is it wise to bet against it in 2012?