Is the market setting up for a Santa rally?

Well, it's back to all doom and gloom right now, after all, the markets were not aware of the prospect of a fiscal cliff in the US a few weeks ago were they. That is of course cynicism, but this is the way markets seem to behave, from almost one extreme to another. One minute the market seems to think that the problems out there are going to be solved, any bad news is brushed aside, etc, markets are going up. Next minute, everything is suddenly gloomy again, good news is ignored, put to one side or overlooked in favour of a bit of doom. The bears and gloom and doomers' are back in force, not that they ever go away, but there has been a change in recent weeks that supports the more negative stance.

Charts were telling us of this potential change in trend a few weeks back, the spring/summer upward run seemed to be exhausting itself and now a downward trend appears to be setting in, the question is for how long?

A few weeks back I mentioned whether we would have the traditional Santa rally this year. At that time the market hadn't sold off and it was difficult to see how an upside could be maintained through to the new year. There was the prospect of further bad news, topping it all being the US fiscal cliff talk which is now looming over the market as we head into December.


Depending on your news source, prospects for a deal are either really bad or likely to go to the wire again. Given that the markets decided to turn negative on the fiscal cliff within hours of the Presidential election being won, it's pretty obvious that they are sending clear signals to the politicians along the lines of give us what we want or our hissy fit can get much worse variety. There is plenty of evidence of this type of market reaction to events in the recent past, the aim to send a reminder to politicians and central bankers of the damage that markets can do if you don't respond by giving them what they want to see. In one sense, the markets add to the potential for crisis by their actions, but ultimately they usually get what they want so playing hardball usually works for them.

So, will we get a Santa rally this year?

Well, first of all the Santa rally period itself tends to be for a relatively short period of time, at most heading into Christmas and then the new year, so it wouldn't be a surprise if we got one anyway, but the bigger question of whether it would be part of a new clearly defined upward trend is more difficult to answer.

I see a couple of possibilities.

If a fiscal cliff deal is done between now and Christmas, markets will rally on that news. This has been the regular response of the markets to any deals since the crisis began in 2007/8, although some rallies have lasted longer than others. Why would it be any different now? If the market really likes the deal and feels it puts to bed some of the major issues for several years, the market response could be very bullish and we could see the current downward trend end very quickly.

An alternative scenario is that the wheeling and dealing over the fiscal cliff goes on right up to Christmas with hints of a deal, good news here, bad news there, further market volatility within the downward trend, but any Christmas cheer delivers a short Santa rally in the hope that a deal is done before the deadline date. The fact that the markets are falling going into December leaves open the possibility of a bounce once oversold conditions are fully reached and so that alone may deliver a Santa rally.

A third possible scenario is that there is no deal, in which case any Santa rally, if it happens is short lived, the new year then may witness falls in markets that haven't been seen since the financial crisis began.The current downward trend actually being the beginning of something more substantial and longer.

My guess is that some deal will be cobbled together if only for the fact that none of the politicians will want to be seen as being responsible for the potential disaster of what happens next. The chances are that Republicans have more to lose here than the President given that he has a recent new mandate. For those in the market, 100% bears and short sellers aside, the deal can't come quick enough.