Do You Believe In Santa? Read More About The January Effect

As long as the market does, it will be a merry Christmas! Santa Claus Rally

We are entering that magical time of the year. No, I’m not referring to the holiday season time of giving and good cheer. I’m talking about that time of year when we get the Santa Claus Rally and the January Effect. The time when investors normally cheer most.

Investopedia defines the “Santa Claus Rally” as a surge in the price of stocks that often occurs around Christmas. There are numerous explanations for the Santa Claus Rally phenomenon, including tax considerations, happiness around Wall Street, people investing their Christmas bonuses, and the fact that the pessimists are usually on vacation this week. Many consider the Santa Claus rally to be a result of people buying stocks in anticipation of the rise in stock prices during the month of January, otherwise known as the January effect.

The “January Effect” is defined as a general increase in stock prices during the month of January. This rally is generally attributed to an increase in buying, which follows the drop in price that typically happens in December when investors, seeking to create tax losses to offset capital gains, prompt a sell-off.

Regardless of whether these occurrences are true or fictional, much like the modern Saint Nick himself, there is no denying that this period is generally a good time for investors. In fact, the S&P 500 has been positive 76% of the time for the period running from the Monday prior to Black Friday until the end of the calendar year.

Now, many people believe that the market rally is solely the work of the Federal Reserve artificially inflating the economy through stimulus and Quantitative easing. It’s hard to argue this fact. Just look at every major drop in the stock market; it’s usually from something causing fear, like news that the Fed will take away the punch bowl. On the other side we see rallies when we get negative economic news, which leads to jubilation because the Fed will keep printing money.

I don’t disagree that when the Fed, either under Ben Bernanke or Janet Yellen, start to taper the stimulus, that stocks will drop. It’s just as I have said here for months, as well as when I stood alone on my last CNBC appearance, I don’t think that there will be any cut back anytime soon. The economy may be improving but there is no way it can stand on its own.

The sad fact is that the demographics of our country and the entire developed world will not support an economic revival for at least another 5-8 years. As I explain in Facing Goliath – How to Triumph in the Dangerous Market Ahead, an economy must have more spenders than savers in order to grow. We know people spend the most in their lifetimes from their early 30’s to their late 40’s, peaking at 48 year sold. Unfortunately, our population is well past their peak spending years, and the next generation of spenders big enough to make a difference, the echo-boomers (the children of the baby-boomers) will not reach peak their spending until 2022.

Ben Bernanke must have seen this coming (yes I will admit that I probably wasn’t the only one), which is why he got out in front of this and started the stimulus programs, and also why they aren’t going away any time soon.

However there are at least two other developments that have emerged, that have received very little media attention, which makes me optimistic: First that America’s oil and gas boom is starting to create “on-shoring”. That is when factories come back to the U.S. to build. Just last week, Foxconn, the Taipei-based electronics manufacturer that builds Apple’s iPhone, announced that it is planning to invest $40 million to build robots in Pennsylvania. American companies usually go to Asia to do their manufacturing, but this time it’s the other way around, and just might signify a new trend. The company Chairman Terry Gou says the company wants to be part of the “manufacturing renaissance” in the US. Hmmm, or should I say wow?

The second development is the recently announced reforms announced by the Chinese government. Even though it has received little fanfare here in the US, many experts are comparing this to the 1978 revolution, when the “Gang of Four” was thrown out, and Deng Xiaoping was named premier. From that point to the present, China has witnessed wildly successful modernization, westernization, and western style capitalization. Chinese per capita incomes skyrocketed, from $100 to $6,000 today, and the new liberalizations could bring Chinese standards of living to that of the American levels.

Of course, those are longterm reasons to be cheerful. In the short term, investors should follow one of the great adages of Wall Street: Don’t Fight the Fed. The Fed keeping money easy with low rates shows how hard they are trying to stimulate economic activity. Another not so talked about reason is that they are deathly afraid of deflation, which means they are not going to stop until they create inflation. We are probably years away before the Fed actually begins raising rates due to a very strong economy. Usually, investors shrug off the first couple of rate hikes. It is not until the Federal Reserve Board hikes interest rates at least 3 times before stocks feel pain. This is known as the “3 jumps and a stumble” rule. Yes you guessed it; the ‘stumble’ refers to the stock market.

Investor Strategy

If you are retired or planning for retirement, now is not the time to take excessive risk. Leave that to people in their 20’s and 30’s. Although I do think stocks are poised to go higher, we are well overdue for a correction or good old fashioned bear market. They are just a natural part of life. Typically bull markets last 48 – 56 months and we are in our 65th month, so watch out and have your exit strategy ready. The price for being wrong is just too great.

You must be extremely careful here to be invested properly so you are getting the best returns, but with the least risk possible. If you are in that retirement red-zone, you can’t afford the risk because there isn’t enough time to make it back. I urge you to take a look at the Springer investment approach, which is designed to manage risk and deliver returns, in any market.