We believe the rally will arrive this year, but with a caveat. Expect this to be more prominent for small caps.
The period between December 15th to January 15th takes into effect the “Santa Claus Rally” period as well as the January effect period. If viewed as a continuous block on the calendar, the December effect (the traditional Santa Claus Rally period), has become as much of a January Effect in recent years.
The reasons for this are debatable, but the historic tendency is not.
Fundamentally
Tax loss selling has become less of a factor recently as the taxability of accounts have been dominated by institutions, which are typically not tax-paying entities, although they do pass their tax-related results down to their end users. Think about this factor this way: the lower the institutional ownership of the stock, the greater the outperformance during the December – January period. This may suggest that individual trading is most responsible for the effect. This makes sense in that taxes have a greater impact on individual investors than institutions. Years like 2022 tend to exhibit strong small cap action with a follow through expected in January 2023, adding credence to tax-loss selling is a key driver.
Currently, Fed speak is still taking front burner status. However, I expect a shift in focus to small cap action to arrive soon. According to Yale Hirsh’s Stock Trader’s Almanac, ( a great read by the way) “In a typical year, the smaller fry stays on the sidelines while the big boys are on the field. Then, around early November, small stocks begin to wake up, and in mid-December, they take off.
What about the effects of a strong dollar? The outperformance of small caps tends to be greater when the US dollar is strong, and weaker when the dollar is declining.
Technically
This year small-caps have lagged behind the Dow and S&P by a wide measure. However, on a historical basis, December and January have a strong trend bias toward small-cap outperformance.
Take for example the Small Cap Russell 3000.The trend toward outperformance has been 100% accurate over the last 5 years. The difference is small……the best was the 2020 to 2021 period with an .86% outperformance. The worst was 2018 to 2018…which was dead even – both were down 4.13%.
We will see how this plays out this year where so much focus has been on the collapse of megacaps. While this trend is not as strong as Election Year cycle trends, it is a trend worth paying attention to.
