Awaiting the Year-End Rally

Usually this time of year investors are not only looking forward to the indulgences of the Holiday season, but they are also waiting eagerly for the year-end rallies in the financial markets. However, this year, it appears there exists a different kind of sentiment, what with the declining housing and credit markets, as well as the almost non-existent consumer confidence.

For the past two decades worth of Decembers, the S&P/TSX Composite managed to rally 19 times, and was a no-show out of the gate only once. Also, gains for the month of December during the same period averaged 2.9% and more, if Stats Canada were to include dividends in the calculations. Compared to other months in a year, Decembers would gain 0.7% above their respective average gains.

So, will the stocks rally in December 2007? Well, I don’t know about other market observers, but my crystal ball is still in the shop and, the way things are going, it might stay there forever. That does not mean there are no theories out there to I cannot lend the benefit of a doubt.

Occam’s razor is a great principle, which when paraphrased states that, “All else being equal, the simplest solution tends to be the best.” In the case of predicting whether a December 2007 rally will materialize or not, the simplest explanation is that December rallies are driven by emotions; people are generally of a much sunnier disposition than the rest of the year.

Happy people are great shoppers, who might also have stocks, bonds and other good stuff on their Christmas shopping lists. Then there is the “ulterior motive syndrome,” whereby both institutional and individual investors do odd things, although these usually serve the greater purpose of pushing the markets in the right direction.

For example, in the last quarter of the year, many investors practice selling off anything and everything to incur losses, which can subsequently be used to offset any gains they might enjoy during the month of December. Also, year-end is the time when portfolio managers’ performances are tallied up. So, they do their best to make those year-end statements “read” like fancy Christmas cards. Of course, never underestimate the effects of pure speculation that if 19 out of 20 times markets rallied this time of year, it’s highly probable that a rally might occur again.

I actually like this “markets-are-emotional-beasts” theory and I do believe it quite possible that the overall Holiday cheer and exuberance might even overshadow the darkest of clouds in the form of recessionary fears spawned by the credit disaster in the U.S. that has already spilled over into global financial markets. Now, I’ve just said something paradoxical, didn’t I?

Of particular interest to U.S. investors was a report from ADP Employer Services that said companies added 189,000 jobs in November — more than three times as many as expected. The data buoyed confidence about the resilience of the economy and prompted economists to boost their predictions for job growth in tomorrow’s U.S. government employment report for November.

Adding to the merriment, the Labour Department said worker productivity rose the most in four years during the third quarter, while unit labour costs — a measure of inflation — fell more than expected.

Whether the December rally will last will depend to a large extent on what the U.S. Federal Reserve Board does at its meeting next Tuesday. If Fed chairman Ben Bernanke plays Santa and delivers a half-point cut to shore up the economy, stocks will probably rally. If he plays Scrooge and only cuts the federal funds rate by a quarter-point, an awful lot of investors could be getting a lump of coal for Christmas.