By Andrew Leckey
Each year Old Saint Nick comes to the aid of weary investors - whether they're naughty or nice - by boosting the stock market in what's known as the Santa Claus rally.
This holiday story has tradition, good cheer and potential riches. Best of all, there's some truth to it because most years have indeed ended on an up note for stocks.
The rationale behind the cheery phenomenon is hazy. Some say it began because so many companies and farmers made their largest profits at year-end. Others more recently note that stock prices tend to rise in anticipation of retirement money being invested in January.
Let's just give the credit to Santa and hope market conditions back up the old boy's good intentions. In 2005, the strongest case to be made for a year-end rally is the fact that things haven't turned out as badly for either the economy or companies as had originally been expected.
Furthermore, the rally tradition is set firmly in the minds of market observers.
"December is the No. 1 month of the year for the Standard & Poor's 500 and the No. 2 month for the Dow Jones industrial average," said Alfred Goldman, chief market strategist with A.G. Edwards & Sons Inc. in St. Louis. "The first couple of days in December tend to be up, and then you get a mid-December moderate pullback that sets up the Santa Claus rally, the most reliable rally of the year."
Two significant trends that favor a year-end rally are in place, namely an economy that's perking up again and the impact of the year's terrible hurricanes now relegated to our rearview mirror. Goldman expects the Dow to be at 11,500 at year-end.
"Technology stocks will keep going up because they've been in the doghouse" said Goldman, adding that the holiday shopping season should turn out fairly decent when all the totals are counted.
Attractive stock prices toward the end of a lackluster year provide another plus.
"It's not worth betting against a year-end rally, since stocks are a good value and for the first time in years people are realizing this," said Dick Green, president of Briefing.com in Chicago. "We see industrials and technology stocks doing well in the fourth quarter, while banking stocks will continue to go up in anticipation of a peaking of interest rates."
Widespread consumer worries about a housing bubble popping or employment slowing down seem to be fading away, said Green, who believes the "swing factor" will be the core consumer price index - an inflation measure without food and energy costs - and whether energy prices create broader pressures.
"Everyone seems worried about a cold winter and natural gas prices affecting home heating costs, but I'm not that worried," Green said. "I expect we'll hear good things about holiday retail sales, and the stock rally will continue to the end of the year."
Green's stock recommendations based on that logic are Texas Instruments Inc. (TXN), Broadcom Corp. (BRCM), Motorola Inc. (MOT), General Electric Co. (GE), 3M Co. (MMM), Caterpillar Inc. (CAT), Citigroup Inc. (C) and Bank of America Corp. (BAC).
Never overlook the power of the Federal Reserve when considering rally potential.
"There is an alignment of forces for a year-end rally," said Richard Cripps, chief market strategist with Legg Mason Wood Walker Inc. in Baltimore. "There's the perception the Fed is near an end to its tightening and that the economy through lower oil prices or sheer momentum will supply the earnings growth to make the market attractive."
Technology, industrials and financials are the fourth quarter's hot tickets, Cripps said. Growth stocks, especially the large-capitalization variety, should do especially well, he said; that means all investors should take a long, hard look at their existing portfolio mix.
"It's time to look for imbalances in your portfolio and avoid them," Cripps said. "Most investors have made their money in small to mid-size stocks and mostly value stocks and that's evident in their asset allocation, but we believe the market will now favor the large, quality stocks."
Cripps' favorite portfolio stuffers include the stock of Microsoft Corp. (MSFT) Boston Scientific Corp. (BSX), Illinois Tool Works Inc. (ITW) and Bank of America (BAC).
"We should make an assault on 1,300 on the Standard & Poor's 500 before the year is out," said James Paulsen, chief investment strategist with Wells Capital Management in Minneapolis. "There was too much pessimism in the wake of Hurricane Katrina, and the economy has continued stronger than most people thought."
A fourth-quarter increase in corporate profits of 12.5 percent is likely, he said. Meanwhile, inflation and both short- and long-term interest rates remain below average.
"There's also phenomenal global growth outside the U.S., including China, India and Mexico, which we'd never have even considered 15 years ago," Paulsen added. "In recent weeks Japan has shown incredible strength and signs of finally emerging economically, which has resulted in an explosive Nikkei stock index."
Own more stocks than bonds, stay diversified and don't violate the basic investment parameters that you have set for yourself, Paulsen said. Emphasize cyclical industries and small-cap stocks that will receive a boost from the economy, he said.
Then, if everything manages to stay in place, Santa Claus should again deliver that year-end rally.
Editor's Note: Andrew Leckey is a regular contributor to The Bull & Bear Financial Report.
