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Santa Claus rally could lead market through 2013

THE Santa Claus rally was late to arrive this year but as we enter December it would seem the sleigh is firing up its engine. By the time we are celebrating New Year's Day the bellwether for global stock markets, the Dow Jones Industrial Index, could be knocking on the door of an all-time high.

The Dow is a miserly 8.5 per cent from the record close touched all the way back in October 2007. The Dow's all-time high carries heightened importance because it also represents the ceiling of a channel pattern that has been in place for 13 years.

If the Dow races to this level and falters then it could be a nasty 2013 for equity markets. Conversely if it clings to this level and then continues its upward march, we can officially declare the secular bear market over.

This bodes well for the local stock market, which should charge towards the 5000 mark, which also represents the top end of a range that has been in place for four years. The Australian market is trading on an average price to earnings (PE) of just 12 times 2013 earnings, which is below long-term averages and cheap, with 10-year bonds sitting about 3 per cent.

Andrew McCauley from Probability points out that December, both in the US and Australia, has the best odds of any month of posting a positive return. The December win rate in Australia over the last 20 years has been 75 per cent, while in the US it is even higher at a thumping 80 per cent, 10 per cent better than the next-best month. On average the benchmark Australian index, the All Ordinaries, has posted a gain of 2.33 per cent in December over the last 20 years and 2.07 per cent over the last 50 years.

Traditionally the Santa Claus rally starts in October, but this year it is slightly out of sync. Both the US and Australian markets waited until mid-November before starting to rise. The Dow has jumped 3.8 per cent higher since the 19th of November while the benchmark Australian index, the All Ordinaries, has kicked 3 per cent.


In the final four weeks of the year stockmarket discussions are going to be dominated by the so-called fiscal cliff. Americans have become obsessed by the cliff with media outlets displaying live countdown clocks to January 1. The fiscal cliff is a combination of tax increases and government spending cuts that automatically come into being on January 1, 2013. Economists have estimated the fiscal cliff could knock as much as 4 per cent off economic growth and push the US back into recession in 2013. This is not what the market wants to hear given the fragile economic recovery currently under way. As we move closer to the cliff's edge, investors are betting a deal will be struck in Washington that prevents a third recession in a decade.

The markets have good reason to believe a deal will be negotiated between President Obama and the Republican-dominated Congress. Despite the US fiscal deficit ballooning towards 100 per cent of gross domestic product, global debt markets are placing little pressure on the American government to introduce austerity measures as we have witnessed in Greece, Spain and Italy. The US 10-year bond is yielding a trifling 1.6 per cent, meaning investors are content to fund US debt. If the bull market in bonds suddenly burst and 10-year bond yields jumped to 3 per cent, the situation would be vastly different.

This effectively leaves the door open for both the President and Republicans to strike an agreement that scores both sides political points but fails to address the long-term debt burden. This may take a few weeks into January to reach and cause short-term conniptions among investors but neither side has the stomach to derail the current economic recovery in return for long-term measures. Historians only have to point out that in 1936, tax increases were pinpointed as a reason for the US economy sinking back into recession in 1937 at a time when the Great Depression was thought to be over. Additionally, a genuine solution to the current debt woes would take many months to thrash out rather than the few weeks both sides have currently.

If I am wrong and both sides of politics dig in their heels and refuse to budge, the US market could well head south from January onwards. This would seem to be the most likely catalyst for the next leg down in the current secular bear market.

In Australia, investors will also be carefully monitoring the machinations in Washington. Just as critically they will be keen to see the Reserve Bank of Australia cut official interest rates to 3 per cent when it meets on Tuesday. The quinella of a fiscal cliff resolution and an interest rate cut at home could see the All Ordinaries Index power up to the 5000 mark in double-quick time.

The next four weeks could set up the direction for markets through the whole of 2013.