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Market Update

Santa Rally Often Hangs Over to New Year’s. This Year, Too?

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December 29, 2014

With three days until the calendar flips, the news flow is expected to be light in below-average volume, but end-of-year position squaring, including year-end fund buying to dress up portfolios, and another flurry of front-loaded economic data could add volatility into the mix.

The final week of the year is sometimes a seasonally strong period for the equity market called a Santa Claus rally. Traditionally, lighter volumes tend to be better for stocks. In fact, there’s an old traders’ axiom that argues “never sell a dull market.” It has tended to be true (maybe just true enough) over time.

You might find it interesting to know that the Dow Jones Industrial Average (DJIA) has been up in the year’s final five trading days 93 instances in its 117 years, or just shy of 80% of the time. So far this year, the market has lived up to that reputation—last week the DJIA set its 38th record-high close of the year, the S&P 500 (SPX) set its 52nd.

A handful of economic stats (consumer confidence, jobless claims, Chicago manufacturing, pending home sales, and more, all detailed in the calendar in figure 3 below) are on tap to test the market before exchanges close Thursday in observance of New Year’s Day. Party-mode aside, most bulls are likely hoping to close the books on a solid year without last-minute noise. Certainly, the market’s “fear gauge” has calmed from the dramatic flares seen earlier in Q4.

Lessons from the Final Quarter?

The decline in the CBOE Volatility Index (VIX), the market’s “fear gauge,” appears to reflect a collective exhale on Wall Street heading into the final week of 2014. VIX is back in the mid-teens after a spike to more than 25 as recently as December 16, then the highest since October. For the year, VIX is on track to end up less than a full point or about 7% from where it ended 2013

FIGURE 1: THE CBOE VOLATILITY INDEX

(VIX) is well off the 25 hit in mid-December and looks to end 2014 up about a point from where it wrapped 2013. Source: TD Ameritrade’s thinkorswim® platform. Data source: CBOE. For illustrative purposes only. Past performance does not guarantee future results.

The final three months of the year weren’t without a few bumps, including two spikes in VIX during the months of October and December (figure 1). The index finished September at 16.31 before rallying to a 2014 high of 31.06 in mid-October. Just a few weeks later, it had crumbled to multi-month lows by the end of November then rallied north of 25 again by mid-December.

Although the periods of volatility in 2014 proved fleeting, the sharp moves in VIX were a reminder of how quickly macroeconomic concerns such as oil price swings or geopolitical rumblings can surface and trigger higher co-movement (correlations between individual stocks) and sudden market sell-offs.

VIX Not Alone

Figure 2 summarizes the percentage changes in the various volatility indices for 2014 and Q4. Oil volatility is the big mover after more than tripling since the end of 2013. Most of those gains came during Q4, and the volatility in oil markets spilled over into the equity market. Gold volatility was up modestly since September. Beyond that, however, equity market volatility indices were down for Q4 but up a bit from a year ago.

FIGURE 2:

Snapshot of various volatility gauges. Data source: CBOE.

Indeed, activity slowed in the past week, and the high anxiety over falling energy prices and lackluster economic data that surfaced in mid-December seems to have receded. Consequently, the S&P 500 rose in three of last week’s four trading sessions and settled at new record highs Friday.

Now, most traders will be keen to keep an eye on market interest rates from the fixed-income space for any signs these markets are pricing in more aggressive Federal Reserve interest-rate action than the Fed is broadcasting. Rates have had their own volatility story. Most market-watchers expected a steady and largely straight climb in interest rates beginning about this time last year. Recall that at this time last year, Street projections called for a benchmark 10-year Treasury yield at 3.25%-3.75% as 2014 wraps. Currently, that closely tracked rate sits at 2.25%. It likely won’t sit there (that’s been said before) but how fast or aggressively will it change? Worth watching.

Needless to say, it will be a sobering return to business as usual as January begins. Normal market hours resume Friday and the first batch of data for 2015 will include the ISM manufacturing index for December and construction spending for November. Then a flood of reports, including the typically market-moving monthly jobs numbers, will drive the market during the first full week of January.

Good trading,
JJ
@TDAJJKinahan

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