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By Lawrence G. McMillan

The idea of a seasonal pattern called The Santa Claus rally came from Yale Hirsch more than 50 years ago.  Simply stated, it says that the market generally rallies over the period including the last five trading days of one year and the first two trading days of the next year.  On average, the rally has been about a 1% move – nothing great, but certainly worth trading.  The seasonal period has just begun for this year: at the close of trading yesterday, Thursday, December 21st. 

Our research later showed that it is part of a larger pattern that encompasses three seasonal patterns: 1) the post-Thanksgiving rally, 2) the January Effect, and 3) the Santa Claus rally.  As such, we are long calls on the Russell 2000 ETF (IWM) for that reason.

But there is another side to the Santa Claus rally – one which has come to the forefront a few times in recent years.  Yale Hirsch stated it this way: “If Santa Claus should fail to call, bears may come to Broad and Wall.”  In other words, if the market declines during the traditional Santa Claus rally period, there may be trouble in early January.  

You may think “Well, that hasn’t happened for a long time,” but it has.  In both late 2014 and late 2015, the Santa Claus rally failed.  That led to poor Januarys in both 2015 and 2016.  January of 2016 was a particularly nasty decline in the market.  So stay tuned as to what this indicator might be about to tell us this year.■

This article was featured in the 12/22/2017 edition of The Option Strategist Newsletter

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