For most children, the days before Christmas are some of the longest of each year. Anticipation builds as they wait for the night when Santa Claus will make his appearance and deliver presents. Investors don’t look forward to Santa’s visit with the same anticipation is children, but perhaps they should. Because most years, December turns out to be quite rewarding.

This year, with the month half over November has brutalized the stock market. The Nasdaq is off about 8% since peaking the last week of October and other major indices have also been hammered. With all the negative news about sub-prime mortgages and weakness in the housing market, many investors are worried that this might be just the start of a major correction.

As I’ve admitted many times, I don’t have a financial market crystal ball and I don’t believe anyone else does, either. But although it is certainly possible that the market could continue to decline from this point, I’m more inclined to believe that we will see a typical end-of-the-year rally with major indices reaching their annual peaks sometime in December. If that occurs, then the next six weeks offer one of the best profit opportunities in 2007.

If you wonder how I can take such a position in view of the market’s current weakness, let me remind you of some recent market history. In the past 16 years, the Nasdaq peaked in December in 1991, 1992, 1993, 1995, 1996, 1998, 1999, 2003, 2004, 2005 and 2006.

I’m sure you remember the three most recent  years when it did not peak in December. In 2000, 2001 and 2002, the economy  suffered from the collapse of technology stocks, the impact of 9-11, and was working through a recession. The Nasdaq still has not fully recovered from the damage of those years.

Of the other two years, I don’t remember much about 1994 because I was in Russia and Ukraine, teaching principles of free enterprise to aspiring businessmen and introducing them to U.S. citizens who were eager to share the American Dream. I know part of the reason it was a bad year for the markets is because the Federal Reserve raised interest rates multiple times. Although the market sold off at the end of 1997, overall it was a good year for stocks with the Nasdaq gaining nearly 22%.

That totals 11 years when the market peaked in December versus five years when it did not. I believe that 2000-2002 were abnormal because of the unusual circumstances. If we disregard those years, then there are 11 of 13 recent years when the Nasdaq reached its annual high in December.

So what does all this mean for 2006? First, let’s look at a chart to assess the current situation. Below we see the Nadaq over the past couple of years. The gold line is a 50-day moving average. You can see that during the current correction, the Nasdaq broke below its 50-day MA, something it has done twice before in 2006. I added the green trendline because that is where there is strong technical support for the Nasdaq. You can see that the index is currently resting near that support level.

The bottom portion of the chart is a moving average convergence divergence (MACD). Right now the MACD is somewhere around -30. During the two previous corrections in 2006 when the Nasdaq broke below its 50-day MA, the MACD has also been negative.

After both of those previous corrections, the Nasdaq rebounded and the losses were quickly erased. If the current correction adheres to that pattern, then the Nasdaq should be on the verge of a sharp upturn–especially when we include the seasonal pattern of a December peak.

There are strong economic and fundamental reasons for stocks to peak in December. The most obvious is that because of holiday spending, December is a huge revenue month for many businesses. Consumer spending makes up two-thirds of the U.S. economy and December is the peak month for consumer spending.

Another reason the market peaks in December is because every fund manager, Wall Street trader, hedge fund manager, or neighborhood broker wants it to. For many of these folks, there are significant bonuses and financial incentives connected to how they finish out the year. So they will do everything they can to make certain that when some guy in Des Moines checks his 401k statement in January that it shows his account reached a new high in December.

Of course there are those who will argue that the problems in the housing market are similar to what the technology market saw in 2000. In reality, the two instances are quite dissimilar. The tech bubble was much bigger than the sub-prime mortgage market and it experienced far more speculation in the preceding months. And there was the impact of the Y2K concerns. People were afraid their computers would not work in the new millennium so individuals and businesses all upgraded their systems in 1999. That meant many did not need new upgrades or software for three or four years–about the time it took for the markets to get back on track.

Anytime the market is correcting, caution is warranted. But so far the overall uptrend is intact and perhaps the best advance any investor can get is to stick with the trend. So unless something dramatic happens between now and Christmas, expect Santa to make his annual appearance and the stock market to have a seasonal rally.

We won’t be publishing a market update next week because of the Thanksgiving holiday. I hope you all have a wonderful time counting your blessings with friends and loved ones.
F.S.

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