Thursday, December 3, 2009

Santa Rally or Rally of a Lifetime?

Let's have some fun for a change. Now that I bored you to death with all my relentless posts on the great pension plunder, let's talk markets.

John Heinzl of the Globe and Mail reports Santa arrives - right on schedule for a market rally:

Here at Investor Clinic, we're skeptical of axioms that purport to hold the secret to achieving great wealth in the stock market. We don't "sell in May and go away," for example. Nor do we time our buys and sells with the U.S. presidential election cycle.

Being fans of the buy-and-hold approach, we prefer to invest - and stay invested - in companies that increase their earnings and dividends. The problem with trying to time the market isn't only that you might guess wrong; you'll also face higher commissions and taxes.

But there is one seasonal pattern that intrigues us enough to dig a little deeper. We refer to the stock market's exceptionally strong performance in the month of December.

Is it just chance that the market almost always rises as the Christmas decorations are going up? Is it an excess of rum and eggnog? Should investors try to take advantage of this trend?

Before we try to answer these questions, let's look at the numbers.

In the past 25 Decembers, Canada's benchmark stock index has risen 23 times and fallen just two, including a 3-per-cent drop during last year's financial maelstrom. The only other losing December over that period was in 1996, when the index slipped 1.5 per cent.

The average gain in December over the last quarter-century was 2.37 per cent, which is more than three times higher than the roughly 0.7-per-cent average advance for all months. With yesterday's 260-point or 2.27-per-cent rise on the S&P/TSX composite index, this December is off to a flying start.

Sure, it could be random luck - but not likely. A few years ago, Thomson Financial crunched the December returns from 1969 through 2005 and found a 99-per-cent probability that something other than chance was behind the outsized gains.

So what factors might explain December's jolly performance?

Well, for starters, there's investor emotion. When the holidays are approaching, people are in a cheerful mood, and that optimism colours their perception of the market. December is also when year-end bonuses get handed out on Bay Street, and some of that cash may be plowed into stocks.

Tax-loss selling may be another factor. In the fall, investors sell their dogs to trigger capital losses for tax purposes, pushing the market down in October and November. But that downdraft attracts bargain hunters who lift prices back up in December, or so the theory goes.

Window-dressing may also come into play. Eager to make their books look pretty for year-end statements, fund managers buy winning stocks as the year draws to a close, giving prices a boost.

A final theory is that the Santa Claus rally is a self-fulfilling prophecy. Because everyone anticipates that the market will rise in December, they buy stocks, and sure enough, that's what happens.

So if December is such a great month, should investors place a big wager on the market on Nov. 30 and sell on Dec. 31, aiming to pocket a quick profit? Unfortunately, it's not that simple.

Although December has produced remarkably good results, on average, there is a lot of variability in the monthly returns, ranging from last year's 3-per-cent slide to an 11.8-per-cent gain during the tech mania of 1999. There have also been several Decembers when the market rose less than 1 per cent, which would barely cover the costs associated with buying and selling an index ETF (depending on the size of the trade and the commissions charged).

It's also important to remember that the December data are backward-looking. Whatever the cause of December's strong performance - it may be one factor, two factors, or a whole bunch of things - it's impossible to know whether the future will look like the past.

"The statistics prove December is a fairly reliable month for good performance in the market, and I can't dispute it," says Tim Burt, CEO of Cardinal Capital Management in Winnipeg. He predicts this December will continue that trend, as the end of the recession and improving corporate earnings give stocks a boost.

But he doesn't advocate trying to get in and out for a quick buck.

"That's a speculative trading strategy. We would never recommend people do that," he says. "We're buy-and-hold, long-term investors. So really what happens month to month is immaterial to us."

The nice thing about being a buy-and-hold investor is that you'll never miss out on big gains - whether they come in December or any other month. So instead of trying to time the market's ups and downs, just sit back and enjoy Santa Claus's generosity.

Just between you and me, in the markets we're heading in, buy and hold isn't going to help you one iota unless you're buying and holding the next big bubble, riding the wave up and hopefully getting out before the rest of the herd gets crushed.

As for the Santa rally, it arrived back in March thanks to Uncle Ben who gave the hedgies and prop trading desks at the major banks a green light to buy every risk asset out there. For those of you still pondering Dubai or do you sell, you're missing the rally of a lifetime:
Royal Bank of Canada says markets are returning to a more normal "performance environment." RBC Dominion Securities today set a 2010 target of 1,200 for the S&P 500 and 12,925 for the S&P/TSX composite index. Good news for investors from chief strategist Myles Zyblock: "The equity market has been on a blistering run since early March, with the large-cap indexes up by just over 60 per cent and bested by the small-cap benchmarks to the tune of a full 10 percentage points. These nine months most likely define the rally of a lifetime … While the embedded return expectations have turned more conservative with time, typical preconditions for a cyclical bear market such as policy tightening, a pending earnings recession or widespread investor optimism remain absent."
I worked with Myles back in my BCA Research days. Glad to see he's finally jumped on board to see that this rally still has ways to go.

I had lunch with Keith Porter on Thursday. Keith was an AVP at the Caisse, successfully managing emerging market equities for over ten years. He's a great guy with a great sense of humor and deep knowledge not just of emerging markets, but of markets in general. You can find his latest thoughts, along with those of others, on the Sceptical Market Observer blog.

Anyways, Keith and I enjoyed sushi and chatted a bit about the pension fund world and markets. He's not sure if he wants to get back into the big pension funds again and I don't blame him. These places are run by politicians and the people that survive are typically the sneaky, weasel politicians who know nothing about running and making money in the markets.

They're not all that terrible. Some are better than others but I told him to proceed cautiously and to look carefully at who is leading the fund. The last thing you want to do is end up working at a big pension fund run by an insecure fool who lusts power. You're better off doing your own thing if that's the only option available to you.

On the markets, we had an excellent discussion covering global banks, China, Brazil and the Fed. Keith thinks that the banks got gifts in the form of free money and the bailouts were a mistake. We both agreed that the UK economy is way too leveraged to the financial services industry.

But his comments on China were particularly interesting. Keith thinks that all this talk of excess capacity in China is missing the bigger picture. He told me that China is planning and preparing for the future so they have every reason to over-invest now and build up their infrastructure and stockpile the resources. It makes sense when you think about it; they saw all the mistakes the Western world made and decided it's best to be better prepared for the future.

There are still problems in China, most notably the disparities between the rural and urban population, but they're making leaps and bounds in almost every area, including clean energy where China is securing first mover advantage in the market for renewable energy.

On the markets, Keith remains sceptical of the rally and recently asked Am I Missing Something? He did, however, admit to me that the liquidity rally can go on for a lot longer than we think.

I told him this liquidity rally is only in third gear and will go to fourth and fifth gear, especially in the hot sectors. He agreed with me that some sectors are already bubbly and will likely get more bubbly as we move along.

And that's where I'll end my comment today. I know some of you got worried about Thursday's late day selloff or are worried about Friday's jobs report. Don't be scared, nothing has changed. Uncle Ben wants asset inflation and he's hoping that it will repair household and more importantly, banks' balance sheets.

And what Uncle Ben wants is what Uncle Ben gets, for now at least. So don't get too flustered or worked up about Friday's jobs report. Either way, the markets will continue to grind higher. Oh, and that major pullback that all the experts are waiting for? It won't happen because everyone is expecting it. The rally of a lifetime still has legs to run.

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