Will Santa Rally the Markets This Year?

With the holidays quickly approaching, investors have one thing on their minds: Will Santa Claus bring plenty of presents under the tree or will he leave them a big fat lump of coal in their stockings instead? After last year’s abysmal year-end performance, there are plenty of questions surrounding this year’s potential for a so-called Santa Claus rally. Conditions are right for the rally, but we have equally just as much uncertainty plaguing the markets. For investors, the markets year-end performance is a tough nut to crack.

But dividends could be the best nutcracker.

Santa Claus rally or not, betting big on dividends could be the best way to play the next few weeks and quarters as the market moves into the New Year. While the rally has plenty of potential, the uncertainty could keep gains in check. And in this sort of environment, dividends could be the top way to get everything you wish for on your Christmas list.

Will Santa rally the markets this year? Dividend investors may not even care.

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The holiday season tends to bring plenty of joy for everyone. This is especially true for investors due to a phenomenon known as the “Santa Claus Rally.” Historically, December has been a great time for investors to be in the market, as over the last few weeks of December into the New Year the major averages tend to rally. And there’s plenty of data to back this up.

According to cyclical and seasonal market data provided by the Stock Trader’s Almanac, the vast bulk of the time Santa does bring investors plenty of presents. Since 1969, the last week of December and the first two trading days of the New Year have managed to produce positive returns in 34 of the past 45 holiday seasons. Over that time, the collective weekly return for the Santa Claus Rally has been an average of 1.4%.

There are numerous theories as to why the Santa Claus Rally occurs in the first place. Some analysts cite year-end tax buying as the reason after tax-loss selling in the early part of the holiday season. Other economists cite the generally happiness and bullishness of the holiday season, increased holiday bonuses and even the fact that institutional investors are on vacation, which leaves retail investors minding the store as the reasons for the rally. Whatever the case, roughly two-thirds of all holiday seasons have resulted in a marked increase during the last few weeks of December into the New Year. You can check out this chart from The Wall Street Journal, highlighting the Santa Claus Rally over the last few decades through 2017.

Source: WSJ.com

What’s important to focus on is the “two-thirds” part. While the potential for a rally is strong, it’s not always the case. A prime example is last year. From the eve of Christmas to the end of the rally period, the S&P 500 sank by 2.7%. This allowed the index to post its biggest percentage decline for a fourth quarter since 2008.

The thing is, last year’s lump of coal from Santa looks awfully similar to today’s. All of that continues to be in line with the uncertainty of the trade war being a top concern.

While both the U.S. and China have agreed to a Phase One deal covering several points and preventing new tariffs, it’s only step one in a long battle. Tariffs on more than $360 billion of Chinese goods still remain and there’s already been plenty of economic damage done to both nation’s economies. And that damage is starting to have a real effect elsewhere as well. In Europe and Japan, we’ve begun to see serious slippages of growth. Meanwhile, the Trump administration has set its sights on the E.U. for a new trade/tariff fight.

On the back of this, we have pretty expensive stocks. Just like last year, the continued rally and lower EPS growth has made the broader markets pretty expensive when looking at a forward P/E metric. None of this screams “year-end rally.”

And yet, there are plenty of green shoots as well. For one thing, the Fed remains very accommodating with its lowering of interest rates, which boosts low-cost capital. At the same time, the consumer remains strong and firms continue to hand back record amounts of cash to investors. Technicians point to the current momentum in the markets as spilling over into the New Year. So, Santa may be hitching up his sleigh and bringing good tidings after all.

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For investors, this poses a real issue. And it’s the same issue we’ve seen pretty much all year – how to play the growth potential while still accounting for all the uncertainty. The answer continues to be a hefty dose of dividend stocks.

Thanks to their lower payments, dividends remain a low-volatility choice for portfolios. The steady cash payments go a long way in helping turn losses into gains in declining markets. For example, data from Capital Group shows that Utilities Select Sector SPDR Fund (XLU), which owns the utilities stocks of the S&P 500, posted a 0.46% gain during the year-end swoon. The S&P 500 managed to lose a total of 6.24%.

Given the equal chance of cola and a great Santa Claus Rally, investors should continue turning their attention toward dividend payers and value stocks that offer a hefty yield. It’s here that investors can source the best of both worlds – stability from uncertainty and a good return if the rally occurs.

Historically, Santa has brought plenty of gains during the last few weeks of the year for portfolios. But not always. This year continues to be a toss up, thanks to continued uncertainty in the economy and markets. To that end, the best way to get into the holdout spirit continues to be a hefty dose of dividend payers. Strong dividends offer the best way to play both scenarios and come out ahead and into the New Year.

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