Santa Rallying on the Back of the Greenback

Good afternoon, 

The S&P 500 snapped a four-day losing streak while Powell snapped his personal losing streak as the most attention-seeking Fed chair. The yen has its biggest one-day jump since 1998, meanwhile FedEx beat its earnings expectations and still saw its share price drop. It's a season of surges to end the year. 

Let’s dive in.

Bottom Line Up Front

• Nike’s quarterly earnings and revenue beat Wall Street’s expectations, but higher costs squeezed the company’s margins (Reuters) 

• Union chief resigns in EU-Qatar bribery scandal (FT)

• Higher Treasury yields have been left wide open after hedge funds unwound SOFR short bets for the end of the year (BBG)

• Mat Ishbia, the billionaire CEO of United Wholesale Mortgage, agreed to buy a majority stake in the Phoenix Suns in one of the biggest deals in NBA history (NYT)

• An activist shareholder has accumulated a stake in Six Flags and is pushing the theme-park operator to sell or spin off its real estate to help reverse a decline in the shares (WSJ)

• The biggest cocaine boom in history is happening right now from the warehouses of Antwerp to coup plots in West Africa (BBG)

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Santa Rallying on the Greenback's Back 

It has been one of the worst years for stocks and bonds in more than a decade – in case you just came back to life after a 11.5 month bender. In that case, you’re just in time for what’s historically been the strongest month of the year for the stock market. 

Not this year. Let’s discuss. 

By December, you’ve seen the client gifting, OOO notices and whatever holiday cheer you can muster up at the end of the quarter roll in. That holiday spirit is typically evident in the US stock market, too. 

In case that analyst who you always catch on TikTok hasn’t told you, stocks tend to close the last two months of the year strong. But, as historical data shows, only one month has been a beast for gains: December.  

The trend was looking to continue again this year. Despite the negativity and the bearish sentiment in U.S. stocks this year, November saw a strong close. The Dow and S&P 500 advanced more than 5%, with the Nasdaq gaining over 4%.

December is typically bullish for stocks, but most of these gains come toward the end of the month. This is typically attributed to one culprit. Enter: the Santa Claus rally. 

Defining the Santa Claus Rally

A “Santa Claus rally” refers to the tendency of stocks and other asset classes to move higher at the end of the calendar year. Specifically, the stock market is observed to move higher in the last five days of the year and first two days of the new year in January. While there’s no concrete definition of a Santa Claus rally, one benchmark is the week prior to Christmas (December 18th) up until the first five days of the new year.

Richard Thaler, Nobel Prize winner more famous for being the older dude next to Selena Gomez in The Big Short, reasoned that investor sentiment can affect EOY trading activity. With Christmas being one of the most widely celebrated holidays across the world, “festive cheer and optimism” may have a positive effect on markets.

Aside from sentiment, what else causes this phenomenon? Likely parties include:

• Tax loss harvesting, since it is the end of the US tax year.

• Less trading activity during the holiday season. Importantly, there’s lower participation from institutional investors, who settle their books near the end of the year. This may leave the market open to your neighborhood day traders.

• End of year bonuses may be invested into stocks or other asset. During a time of lower trading volume, the actions of these investors splashing some cash may have more of an impact on asset prices.

Now, back to this year. Markets have been acting more anxious than first-year bankers awaiting their bonus (or lack thereof this year). The S&P 500 snapped a four-day losing streak amid the BOJ’s surprise and nervousness about the Federal Reserve’s potential rate-hike path.

Tech stocks are among the biggest losers as increased borrowing costs make them less attractive. More insights on inflation will arrive Friday, with the Personal Consumption Expenditures (PCE) Price Index for November. The yield on the 10-year Treasury note was higher. Talk of recession raised concerns about oil demand, driving crude futures and shares of fossil fuel companies lower.

In short, these renewed fears of a US recession put further pressure on equities as the S&P 500 ended last week 2.1% lower. Trading was especially volatile on Friday with $2.6T worth of options expiring as part of triple witching day. Aggressive rate hikes by four major central banks of the world are a testament to the continued monetary tightening we are seeing around the globe. 

A Year in Review for USD 

Between interest rate speculation and the currency’s safe haven role, we have seen bearish pressure on USD level out to uncertainty for the market this past week. Historically, the final two weeks of the year typically see a significant drop off in liquidity (volume and open interest) as the last salvo of major global event risk and policy decisions are usually cleared. 

In this highly volatile and difficult year for currencies and equities, the US dollar has been a safe haven for investors. 

The US dollar was the 2022 currency to beat. In the end, it was only succeeded by the currencies of some Latin American countries, the Mexican Peso and the Russian rouble. 

As a reserve currency, the US currency is a special one. In troubled times, the currency is strong, but it is also strong when the US economy is performing well. Only in the periods in between, poor fundamentals such as twin deficits surface. 

TL;DR - think of this period as the dollar’s “smile.”

USD Just Hijacked the S&P’s Uber

Strictly defined, the Santa Claus rally is a steady increase in stock prices. Since the 1993 inception of SPY, a Santa Claus rally has driven up prices two-thirds of the time. From 1950 to 2000, a Santa Claus rally happened in 70% of those years. But when Santa’s missed his S&P pre-game, can the USD sub in? 

The greenback has provided exceptional stability, with almost every currency around the world declining against the U.S. dollar in 2022.

Intuitively, it would make sense if a Santa Claus rally were confined to retailers who make most of their profits in the span of time between Black Friday and Christmas. However, the rally applies to the broader market. Other explanations include prices going up as investors and traders buy and sell based on tax considerations and that folks are buying into an anticipated January effect when stocks also tend to go up. 

A contrarian view says that sophisticated institutional traders who tend to be pessimistic sorts take the holidays off, which leaves the market to mom and pop investors who tend to be more optimistic.

So Will There Be a Santa Claus Rally This Year?

The best Santa Claus rallies in the past two decades were in 2007, 2013, 2015, 2020 and 2021. But the 2007 Santa Claus rally was followed by the Financial Crisis, when the market lost about 40% going into 2008. The 2021 Santa Claus rally was followed by this year’s dismal performance. 

On the other hand, the Santa Claus rallies in 2013, 2015 and 2020 were followed by impressive bull markets. As such, the question is not if 2022 will have a Santa Claus rally, but if we will see a market recovery in 2023 as the Fed achieves a soft landing, Russia stops its war in Ukraine and China continues its Covid zero policy pivot.

As in any market, you can make money from movements. A rally leading up to the 23rd is not assured – as you could obviously tell today when opening up your Terminal. That means you can’t just buy SPY, hold it for a few days, and sell before the market closes on Christmas Eve. 

The Fed has shown inclination to slow down the rate hikes, which could  provide some tailwind to the bullish momentum. All set for a good end to the year?

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