Will Santa come to town this Christmas?
After the stock market’s vicious drops in the past weeks, people are wondering if there will be a Santa Claus rally?
The major stock indices (DJIA and S&P 500) are down more than seven percent from their all-time highs as it appears we have yet to see the worst of the sub prime mortgage meltdown. In fact, Wall Street’s largest banks and brokers are expected to write down as much as $70 billion this year on sub prime-related losses. On Friday, investors’ doubts were further reinforced as Fannie Mae (the biggest home lender in the
Perhaps, Santa came to town early. Ben Bernanke’s decision to lower the Fed funds rate and the discount rate by 50 basis points two months ago was like a gift. It felt like Christmas in September as the stock market rallied strongly after falling sharply in August.
Rising volatility
Investors have never been more edgy during the past three years than now. In fact, volatility in the stock market as measured by the Volatility Index (VIX) has risen to its highest level since February 2003 as shown below. Also known as the “investors fear gauge,” the VIX (main window) measures market expectations of near term stock volatility conveyed by S&P 500 index (middle pane).
Note the strong correlation of our own PSE index (bottom pane) with the S&P 500 index and the VIX. Every time there is a sharp rise in the VIX and the S&P 500 pulls back, there is also a pull-back in the PSE index. Similar to the DJIA and the S&P500, the PSE index is down more than seven percent from its record high set in October.
Santa Claus rally and the January effect
Nevertheless, we are not discounting the so-called Santa Claus rally and the January effect which often show that the months of December and January are seasonally strong months for stocks. We’ve written about these two years ago (see the
The month of December is normally favorable to stocks having gained an average of 5.6 percent for that month during the last 20 years. Looking back, 14 out of the last 20 Decembers (or 70 percent of the time) ended up positive for the month.
The following month of January likewise tends to be good for stocks, returning an average of 3.9 percent during the last 20 years. Also, 14 out of the last 20 Januarys (or 70 percent of the time) registered month-on-month gains.
Taking into account the combined December to January period, you will notice that 17 times during the last 20 years (or 85 percent of the time) the average return for those two months is positive.
Confusion in the markets
With the expectations of a year-end rally but in the face of rising volatility, investors are now confused on what to do. Again, we recommend that you go back to the basics of investing:
1) Determine your investment horizon. If you are investing only for the short-term, it may be advisable that you just stay on the sidelines, or else risk being whipsawed by the markets. However, if you have a long-term horizon (like us in Philequity), it is ok to ride out the volatility. In the long-term, stocks outperform bonds and cash.
2) Review your risk profile. If you are in cash, you would probably choose to invest in stocks at this point. However, if you are overextended, you would probably want to scale back to a level that you are comfortable with.
3) Practice diversification and asset allocation. These are investment strategies which we’ve already discussed in preceding articles.
4) Do intensive research on the companies that you will be investing in. Consider the earnings and growth prospects, credibility and integrity of the management, extent and possibility of dividends. Good companies (as long as it is properly managed) will grow on its own as the economy grows. As Warren Buffet said, “Buy the business and not the stock.”
For comments and inquiries, you can email us at [email protected]. You can also view our archived articles at www.philequity.net or www.yehey.com/finance.
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