Algorithms Will Dominate Any Santa Claus Rally

Traders expecting a six-year low to be the bottom of crude oil’s drop saw it slide to even lower levels, then bounce this morning. Markets must weigh cheap oil and bargain hunting while many hope for a Christmas rally.

Some Await Xmas Rally As Oil Bounces

The seasonal tendency is that the last five trading days of the year and the first couple days of the new year see a small uptick in prices. The volume is typically not huge. My friend Jeffrey Hirsch, editor of Stock Trader’s Almanac and son of Yale Hirsch, the man who first identified the trend, likes to call it “window dressing” by portfolio managers trying to look as good as possible in their quarterly reports.

The rally is sometimes called the Santa Claus rally, though unlike the real Santa Claus, it doesn’t differentiate between naughty and nice traders. It tends to boost stocks and ETFs that are already performing well and hurt weaker ones. The simple reason is that managers want to look as though they were smart enough to have loaded up on the good ones from the beginning and had never even touched the stinkers.

So when your broker tells you he’s been in Tesla since the summer and knew the Apple Watch was going to be a hit, he may well be telling the truth. But he may also have loaded up on more shares to make himself look extra smart.

As oil prices look like they have found support for now, the race to dump energy stocks has abated. But beware of misreading the headlines and thinking that traders are now less bearish on oil or energy companies. Funds and individuals are buying put options in crude oil futures down to the $15 level in volumes not seen since the late 1990s.

In situations like this, with bargains to be had among the stocks that have dropped, and a rally expected because, you know, Christmas, some traders start to take the word “speculator” to heart and really try to get clever. That’s when you see smaller buying sprees led by bargain hunters looking to pick the now-cheaper stocks dropped by others. Energy stocks are the big winners of that mini-buying spree. It has saved them from further struggles for now.

All of this could reverse by the end of trading on Christmas Eve, however. Volume is lower as many portfolio managers are choosing to stand pat or simply starting their holidays. Most of the risks worth taking—the big bets on the Fed’s interest rate hike and the major moves in crude oil early this fall—have already been taken. For most investors, there is not much incentive to put their money out there and expose themselves to further risk.

The S&P 500 has cut its December decline to just two percent and the US stock market as a whole is finishing 2015 virtually unchanged from a year ago. It may not have been a banner year for the index, but for funds which bought the August decline, 2015 was profitable. For their managers, it’s time to call it a year.

Algorithmic trading looks likely to dominate any Santa Claus rally that does develop, pushing small rallies further and adding volume to volatility. While analysts may attribute any such rallies to one or more news items, the most likely reason will be that the algos, like the good traders they are, will simply be following the trend.

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