Santa Claus Is Coming To Town But Will A Market Rally Follow?

Includes: DIA, SPY
by: Jamin Chen

Santa Claus is coming to town, and perhaps the Santa Claus rally is not too far behind. You'd better believe it. Although the Santa Claus rally is not a sure thing, historically it has come true more often than not.

Lest some of you impulsively get into the rally now, let me curb your enthusiasm and point out that you may be too late already.

Like the planners for the Christmas sale events in the department stores, you have to lay out the groundwork early on, often as soon as the last rally is over. Just as the department stores do, you should have been stocking up your inventory long ago, and by now you should be in selling mode. This means keeping your eyes open year round looking for buying opportunities, such as the summer doldrums, to stock up for the year-end rally.

The stock market is an aggregate of people’s actions, with all of us trying to maximize profits, whether with our own money, or with other people's money, as managed by fund managers working hard to get fatter bonuses. Therefore, if I were a fund manager, it would be in my interest to have a year-end rally, and if enough people try to make money off the year-end rally, we would in fact be staging one by buying until the rally was over.

If you draw a straight line from the August low of S&P=1120 to the December 7, close of 1261, you could think the rally would go on. How high would it go? A simplistic extrapolation would indicate that it could reach around 1360 toward the end of February 2012.

In May of this year a high of 1370 was reached. Many investors who didn't cash out at the time may want to either recover their losses or realize their gains once this S&P high is approached again.

As always, in the next month or two, the market will have its gyrations. A rational trader would try to take advantage of the rally if it does take place and bail out before it peaks or fizzles. If the S&P zooms through 1370, that would put us in new territory, calling for a different analysis and strategy.

Anyway, to get onto Santa’s bandwagon now, there are only 100 points or so to go to reach the May high, and the chance of getting some quick money gets slimmer by the day. It is tempting, but personally I would not do it.

I trade in DIA and my personal strategy in the current rally is this: I have already set up to sell a fixed amount of DIA (like 100 share each) with each fixed rise (like every $2 rise) in its price until my “Christmas inventory” is exhausted before S&P reaches 1360, with no replenishment of my DIA inventory above $120. I stocked up my Christmas inventory about a month ago when DIA was in the low $110s.

Disclosure: I am long DIA.