It’s mid-December, and everyone wants to know if stocks—and by extension high-yield closed-end funds (CEFs)—are poised to roar into ’24 in a so-called “Santa Claus rally.”
I’ll venture a prediction, but before I do, I should tell you that I come at the whole idea of a Santa Claus rally from a bit of a different angle than most folks in the business media or on Wall Street.
I actually dislike Christmas cheer in the markets. Not because I’m a Grinch. Rather, it’s because I think Santa rallies are not a good sign for stocks going forward.
Take 2021, a year in which market sentiment whipsawed. But in late 2021, the outlook for stocks was strong—few expected the crash waiting for us in 2022. Thus, the market soared in December of that year.
To put that 5.8% jump in context, the average return in December over the last 20 years is 0.79%—a fraction of the gain we saw in December ’21.
Thus it’s clear that going into 2022, the market was overeager—the perfect time for fear to take over and spark a crash at the first sign of weaker data (which came quickly in the form of higher inflation, spurring last year’s quick run of rate hikes from the Fed).
Similarly, the “coal” that December 2022’s “Santa slump” put in our stockings (I’m not sure what to call it when markets fall in December) was overdone in the other direction. The S&P 500’s 5.9% decline in December 2022 is the third-worst over the last two-and-a-half decades, a bit behind 2002’s 6% fall and 2018’s 9.2% drop.
That history is important here, because the 2002 and 2018 “Santa slumps” were gifts to contrarians, with the S&P 500 soaring almost identically the following year, with total returns of 26% in 2003 and 25% in 2019.
And year to date, the pattern has held, with the S&P 500 returning 22% so far in 2023.
It’s pretty clear from the above that there’s an inverse relationship here: a strong rally in December increases the odds of a weaker market the following year, while a weaker December increases the chances of gains.
Which brings us to today: if the S&P 500 moves lower in the coming days, it increases the possibility of a stronger 2024. If stocks soar, it could be a sign of bad news to come—or at least that’s what history suggests.
But even with that in mind, there’s another reason to think a Santa rally could hold up into 2024. To see why next year might indeed be different, let’s dig a little deeper and examine the performance of the benchmark ETFs for various market sectors over the last 11-and-a-half months.
So far in 2023, we’ve seen the 50% gain in the Technology Select Sector SPDR ETF (XLK) drive the market’s gains, on the strength of AI’s rapid growth: tech titans NVIDIA (NVDA), Palo Alto Networks (PANW) and Advanced Micro Devices (AMD) are all up 100% or more year to date.
Tech’s dominance is also why the Communication Services Select Sector ETF (XLC) is up 46%: its two biggest components, Meta Platforms (META) and Alphabet (GOOG), are up 115% on average between them for 2023.
Those outsized returns from tech (which, let’s remember, was the hardest-hit sector in the 2022 crash) means the S&P 500 as a whole isn’t really in a bull market—not yet.
If there is a Santa rally—and especially if that rally is driven by sectors beyond tech—it would mean the market is finally in bull market mode. That would be the dominant narrative, meaning the media will be incentivized to try to pick it apart. Or worse, prompt investors to overlook the point when good data starts showing signs of weakness.
But if we see “coal” in the markets over the next few days, it means there’s still a lot of value to double down on a market that still has not fully recovered from 2022’s selloff.
What if stocks don’t move too much in one or the other direction? In that case next year is likely to involve more caution.
Which way will this ultimately break? I think the sideways-market setup is the most likely, but the coming days will tell the tale. Either way, we’ll take note of whether volatility increases or collapses and adjust our course accordingly in CEF Insider.
Michael Foster is the Lead Research Analyst for Contrarian Outlook. For more great income ideas, click here for our latest report “Indestructible Income: 5 Bargain Funds with Steady 10.9% Dividends.”
Disclosure: none