A failed Santa rally, now what?

Posted by Cam Hui -
Preface: Explaining our market timing models

We maintain several market timing models, each with differing time horizons. The “Ultimate Market Timing Model” is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

 

The Trend Asset Allocation Model is an asset allocation model that applies trend-following principles based on the inputs of global stock and commodity prices. This model has a shorter time horizon and tends to turn over about 4-6 times a year. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can be found here.

 

 

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don’t buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the email alerts is updated weekly here. The hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.

 

 

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
  • Trend Model signal: Neutral (Last changed from “bullish” on 15-Nov-2024)
  • Trading model: Bullish (Last changed from “neutral” on 19-Dec-2024)

Update schedule: I generally update model readings on my site on weekends. I am also on X/Twitter at @humblestudent and on BlueSky at @humblestudent.bsky.social. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of those email alerts is shown here.
 

Subscribers can access the latest signal in real time here.

 

 

Santa has left for the year…

As I pointed out last week, the Santa Claus rally window is the last four days of the year and the first two days of the new year, and it’s one of the seasonally bullish periods of the year. History shows that a failed Santa rally often leads to subpar returns for the remainder of the year. The first day of the window was December 24 and the last day was January 3.

 

Santa has failed to call this year. The S&P 500 and the Dow closed above their respective Santa rally levels, though the Russell 2000 was marginally positive.

 

 

If adage about the Santa Claus rally is to be believed, the odds favour a subpar year in 2025 for the S&P 500: “If Santa should fail to call, the bears may come to Broad and Wall”.

 

 

 

Poised for a rebound

Before you turn overly bearish, you have to consider the short- and medium-term outlook. In the short term, the market remains highly oversold and poised for a rebound.

 

Even as the S&P 500 tests its recent lows, it’s flashing a series of positive divergences, as measured by its 5-day RSI, NYSE McClellan Oscillator, and NASDAQ McClellan Oscillator.
 

 

The latest bullish data point comes from the NAAIM Exposure Index, which measures the sentiment of RIAs who manage individual client funds. A buy signal is issued whenever NAAIM falls below the lower 26-week Bollinger Band. The latest reading shows the index within a hair of that threshold, which I interpret to be close enough for a buy signal.
 

 

This indicator has shown a near 100% historical success rate in its track record. I interpret these conditions as the path of resistance for stock prices is up, at least in the near term.
 

 

The bull’s challenge

The key to the intermediate health of the bull market is its behaviour during the anticipated rebound. Walter Deemer recently voiced concerns that current technical conditions resemble the Nifty Fifty market top in 1972. This isn’t the dot-com bubble, when most of the bubble companies had no earnings. The AI-related stocks today have earnings and exhibit strong growth, much like the Nifty Fifty.

 

 

The warning in 1972, just as today, is showing up in the form of negative breadth divergences. Advance-Decline Lines, however they are measured, are all weaker than the S&P 500.
 

 

There are, however, some rays of hope.

 

The smaller stocks within the S&P 500, as well as the small-cap Russell 2000, are showing early signs of relative strength, which are indications of broadening breadth. If this trend were to continue during the anticipated rebound, that would give the bulls some hope that the top isn’t in yet.
 

 

Another constructive sign is the positive divergence exhibited by the junk bond market. The relative performance of junk bonds to their duration-equivalent Treasuries has reached a new high, even as the S&P 500 remains below its all-time high.
 

 

In conclusion, the Santa Claus rally didn’t come for stock investors this year. Perhaps he misread the calendar and confused it with the Julian calendar of the Ukrainian and Russian Orthodox Churches, which celebrates Christmas on January 7, though Ukraine switched its Christmas to December 25 to divorce itself from Russian traditions because of the war.

 

I believe investors need to consider short- and intermediate-term market conditions separately. Current market weakness has left the market poised for a reflex rally. The key to the intermediate-term outlook is the market’s behaviour during the anticipated rebound. Can breadth broaden out and more stocks participate on the upside?
Here are some questions to consider as the likely rebound develops in the coming days as ways to measure the health of the bull market:

  • Can the S&P 500 and Russell 2000 break out through the (dotted) falling trend lines?
  • How will each index behave if they reach the top of their respective trading ranges?
  • Can the small cap Russell 2000 outperform, which would be a constructive sign of broadening breadth?

 

 

Stay tuned.

 

My inner trader continues to hold a long position in the S&P 500. The usual disclaimers apply to my trading positions.

I would like to add a note about the disclosure of my trading account after discussions with some readers. I disclose the direction of my trading exposure to indicate any potential conflicts. I use leveraged ETFs because the account is a tax-deferred account that does not allow margin trading and my degree of exposure is a relatively small percentage of the account. It emphatically does not represent an endorsement that you should follow my use of these products to trade their own account. Leverage ETFs have a known decay problem that don’t make the suitable for anything other than short-term trading. You have to determine and be responsible for your own risk tolerance and pain thresholds. Your own mileage will and should vary.

 

 

Disclosure: Long SPXL

 

2 thoughts on “A failed Santa rally, now what?”

  1. The total focus of MAGA is now unleashing technology. The tech billionaires have put Trump and Vance (the next Techno-President) in office according to them and they will dictate policy. I didn’t understand the scope of their drive until I listened to the interview video with Marc Andreessen below. He was a big Democrat supporter that flipped to Trump in the summer. This is a must-watch video to understand the grand plan that will unfold.

    I don’t see a broadening of stock market performance here to other sectors. I see disruption in businesses (more efficient in the long run but corporate losers failing now) and labor-saving (high unemployment). This will not sit well with MAGA supporters than will be getting the short end while the tech elite thrive.

    Tech elites see an unleashing of tech startups and a boom in the tech industry. This will likely take all the investor oxygen out of the room like it did last year from other sectors. They also will make sure the big big companies get bigger without regulatory restraint. In Trump’s mercantilist world view, National Champion companies are to be helped not hurt.

    Listen to the video and you may come away, like I did, focusing on technology as THE key sector where we are not currently near a bubble peak. Step one, I’m developing a trading strategy around the TECH Momentum ETF (PTF). It will regularly rebalance to winners and winners in this tech-friendly future could do amazingly well.

    This is all just an observation and not a recommendation since I don’t know your financial circumstances. Here is the video.

    https://www.youtube.com/watch?v=sgTeZXw-ytQ

    1. Hi Ken,
      Thanks for your ETF tip of PTF.
      These days I often compare the performance of any ETF against the “benchmark” of MAGS. If I look at a comparison since Nov 2023 it appears that they perform quite similarly though MAGS has still out performed PTF by a tiny bit.
      This is not to say that PTF is not a good idea as it has the advantage of providing more diversification.

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