Will investors be treated to some early Christmas cheer?

Known as the Santa rally, the final month of the year is typically the best for stock markets

Nick Donaldson / The National

Even in the toughest of years, investors always have something to look forward to. That something is December, as the final month of the year is typically the best for stock markets.

Shares are more likely to deliver a positive return in December than any of the other months, in a phenomenon sometimes called the Santa rally.

November can be a pretty good month, too, making this the most wonderful time of the year for investors.

It’s not foolproof, it’s not fail-safe and it doesn't always happen, but history shows that markets often end the year with a celebratory bang.

Almost everybody loves a party, yet they are not without their pressures.

Investors who have been sitting out this volatile year in cash now have a decision to make. Can I afford to sit on the sidelines while everybody else indulges in a little fun?

There is another question: what happens when December is done?

The fanciful notion of a Santa rally is backed up by cold, hard data, according to new research from investment platform Bestinvest by Evelyn Partners.

It studied the performance of the MSCI World Index for the past 50 years and found equities were more likely to deliver a positive return in December than any other month, and by a long shot.

Over that period, equities posted December gains 74 per cent of the time, against an average monthly gain of 62 per cent.

There are several theories explaining why December sprinkles a little magic, says Bestinvest managing director Jason Hollands.

“One is that markets get a boost as fund managers invest spare cash to ‘window dress’ their portfolios ahead of reporting periods,” he says.

“Another is that hedge funds close their short positions before the year end, which involves buying back the shares they have been betting against. Some argue that the Santa rally may simply reflect a natural tendency towards optimism as the new year approaches.”

Investors have spent this year trying to second guess when interest rates will finally peak and whether economies will slip into recession or enjoy a soft landing, Mr Hollands says.

Equity performance has been surprisingly positive after the crash of 2022, with MSCI World returning 10.8 per cent and the S&P 500 up 13.4 per cent.

However, it has been a strange kind of recovery.

“Gains have been concentrated in potential beneficiaries of artificial intelligence, notably the so-called ‘Magnificent Seven’ US mega-cap giants Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia and Tesla,” Mr Hollands says.

When technology stocks are excluded, the S&P 500 is up a mere 1.9 per cent.

Europe has fared reasonably well, with the Euro Stoxx 50 Index up 14.26 per cent, but the UK’s FTSE 100 has struggled and emerging markets have also drifted downwards.

Now, optimism is in the air as 2024 looms. Inflation is falling, interest rates appear to have peaked and investors are looking forward to rate cuts at some point.

November was upbeat, as it often is, with the S&P 500 jumping 8.9 per cent to snap a three-month losing streak. That’s its second-best November since 1980.

A traditional mix of stocks and bonds soared last month, setting the 60/40 portfolio up for its strongest monthly performance since 2020, according to Bespoke Investment Group.

With markets starting brightly in December, investors are hoping for more festive joy to come.

Chris Beauchamp, chief market analyst at online trading platform IG, says the latest personal consumption expenditures (PCE) price index figure for the US, an indicator closely watched by the country's Federal Reserve, showed inflation rose just 0.2 per cent in October and 3.5 per cent over the year.

“Fed chair Jerome Powell is now permitted to think about ticking off inflation from his 2023 to-do list,” he says.

Fresh signs of weakening inflation in the eurozone lifted European and UK stocks, Mr Beauchamp adds.

“In both cases, the effect has been to bring forward the expected date of the first rate cuts, providing more hope that 2023’s era of higher rates will be left behind in 2024.”

The bad news is that a Santa rally does not automatically herald a brighter year ahead, warns Russ Mould, investment director at UK advisory group AJ Bell.

His data shows the UK’s FTSE 100 climbs an average of 2.2 per cent in December, more than any other month, but January can bring headaches.

“The FTSE 100 has served up 11 annual losses since 1984 and 10 of those came after a gain in December of the previous year,” he says.

Worryingly, some of the best Decembers were followed by the most treacherous years, with the tech bubble of 1999 a notable example and the dot-com crash that quickly followed, he adds.

“By contrast, some grim Christmases – 1985, 1990, 1994, 2002 and 2018 – have been followed by cheerful years,” Mr Mould explains.

Charu Chanana, market strategist at Saxo Bank, says markets now anticipate a Santa rally as we appear to have reached the long-awaited Fed “pivot” on interest rates, but they’re ignoring the threat of a recession in 2024.

“Sustaining the year-end rally, if we were to get one, could remain difficult,” she adds.

There are geopolitical uncertainties, too, including the war in Ukraine, events in Gaza, Chinese-US relations and presidential elections in the US that could possibly see the return of Donald Trump.

Carsten Brzeski, ING’s global head of macro, is wary, declaring that “2024 will not be the year the global economy sees a strong rebound” and investors will to have to look harder for the positives.

“In China, the lack of new fiscal stimulus suggests we'll see a further loss of growth momentum,” he says.

“The correction of the real estate and construction sector looks likely to continue. Derisking in the US and Europe will also put more pressure on Chinese growth.”

In the West, the “delayed impact of the monetary policy tightening and a lack of significant fiscal stimulus” will leave a mark on the real economy, he adds.

The one positive is that a slide into disinflation may allow central banks to cut rates.

“This turnaround in monetary policy by the summer should point to lights at the end of the tunnel, improving the outlook and mood in the second half of the year,” according to Mr Brzeski.

Turning things around takes time, he cautions.

“No one has a magic wand to make the world brighter than it is. More's the pity.”

Enjoy Christmas, rally or no rally. Either way, 2024 is likely to bring us all back down to Earth again. Possibly with a bump.