What exactly is this Santa Claus rally?
One of the interesting, perhaps irrational, stories in the stock markets is about the Santa Claus rally. It goes something like this. In the last few weeks of December, stock markets tend to rally sharply. There is an eminent logic to it. Christmas and New Year are the time when consumers the world over open their purse strings and tend to spend on food,wine,clothes, consumer durables; and the list goes on. In the last few years, ecommerce players like Amazon, Alibaba and Flipkart ensured that customers are induced to buy around Christmas and New Year with everything from discounts, coupons, attic sales and gifts.
But why does that result in a stock market rally? That is not hard to fathom. More spending means more revenues and profits for companies. It also means that money churns faster in the economy giving a boost to growth. Of course, the proof of the pudding lies in the eating. If you look at stock markets over the last 70 years since 1950, the Dow Jones has given a Santa Claus rally in 4 out every 5 years. That is an 80% probability of having a Santa Claus rally each year.
It was a long, long Santa Claus rally
If you look at the Nifty chart over the last 9 months since the Nifty bottomed out, it has also been a one way journey, gaining nearly 78%. But that was, perhaps, the end of uncertainty. The second big positive signal came towards the end of September 2020 when advance tax numbers indicated that profits for the Sep-20 quarter would be better than anticipated. But the real base for the Santa Claus rally was set in the end of October 2020 by a combination of factors.
By late October, opinion polls were indicating a clear victory for Joe Biden. By then Q2 results had started to flatter the street. To add punch; both the US Fed and the RBI promised almost unlimited liquidity infusion till growth returned. All this meant that FPI suddenly moved from being cautious to bullish about emerging markets like India. That explains why Rs115,000cr flowed into Indian equities since late October.
Santa Claus has issued some rally warnings too
It is said that the entire world is happy when Santa comes and that is also true of the Santa Claus rally. However, the Santa Claus rally has been triggered by optimism and liquidity and there are words of caution. Here are pearls of wisdom to glean from the Santa Claus rally.
• The higher you go, the smugger you become and the smugger you become, the harder you fall. Unfortunately, that applies to the stock markets, especially considering the kind of Santa Claus rally we have seen this year.
• Why does Santa only come once in a year? That is because good things come in doses and that also applies to stock market rallies. In the last 1 year, it has been too many good things happening in the market in a short span of time. It is time to be cautious.
• There is an interesting aspect about Christmas in that Santa Claus supposedly only gives gifts to children who behave well. Similarly, these markets will reward you only if you follow the basic discipline of risk and returns in stock markets.
• Santa reminds us that nothing is really permanent. In early March 2020, we thought markets were finished and today most investors believe that the markets can only move higher. Santa is a reminder that just as bad times doesn’t last forever, nor do good times.
• Finally, don’t forget the Santa Ledger. The ledger tells us that even as Nifty and Sensex are scaling new highs, Indian economy is likely to contract in FY21, exports are falling and jobs are hard to come by. When we look at the rally and into the next year, let us not forget the ledger which holds the real story of the Indian economy.
Let us end on a positive note for Christmas. The rally has left all of us with a feel-good factor and it is a good way to end a tumultuous 2020.
Wishing you a Merry Christmas and a Happy New Year!