The Santa Claus Rally: Will the Stock Market Reach New Highs in 2023?
As we approach the end of the year, the stock market is gearing up for the famed “Santa Claus rally.” Barring any unforeseen escalations in the Middle East, this week should be a positive one, potentially delivering new highs for 2023. With light trading volumes, positive news could drive the market higher.
A Broadened Stock Market Rally
The stock market rally has expanded significantly, with even the S&P 500 Equal Weight Index (SPXEW) reaching new 52-week highs. This is a stark contrast to the end of October when the SPXEW was at its lowest point in a year. The fact that small caps and financial stocks are rallying suggests that the market does not anticipate a recession in 2024. While market sentiments can change, all signs currently point to a bullish outlook.
The Post-Pandemic U.S. Economy
The post-pandemic U.S. economy has confounded many economists, as it has managed to withstand the Federal Reserve’s tightening cycle. Despite this, the shortage of workers has led to a decline in the unemployment rate to 3.7 percent. With so many people employed, it is difficult for the economy to enter a recession.
Additionally, the shortage of houses has driven housing prices to all-time highs. Just two months ago, the 30-year fixed-rate mortgage came dangerously close to 8 percent. However, it has since fallen to 6.75 percent and continues to decline. This low mortgage rate is expected to support a robust housing market, despite low inventory. Homeowners with low mortgage rates are reluctant to sell, and homebuilders remain cautious due to the housing crash of 2007–09. As a result, there is a significant shortage of homes, estimated to be between three million to five million units.
The Real Reason for Last Wednesday’s Sharp Selloff
Last Wednesday’s sharp selloff, which lasted only one day, can be attributed to the trading of zero-day-to-expiration options (0DTE). With $900 billion in notional value traded, it is evident that these options played a significant role in moving the market. Professional traders often trade 0DTE options from the short side, taking advantage of their fast decay in value as they approach expiration. On the other hand, retail traders tend to buy these options, hoping for big paydays but often facing losses over time. The prevalence of 0DTE options has made every trading day feel like an option expiration day, leading to sudden swings in the market.
About 50 percent of option volume in 2023 has been 0DTE options, and this percentage continues to grow each year. These options have become increasingly popular since their introduction in 2005, allowing traders to trade options with expirations on every trading day of the week. While they can offer opportunities for quick gains, they also come with significant risks.
In conclusion, as we approach the end of the year, the stock market is poised for a potential Santa Claus rally and new highs in 2023. However, the market remains susceptible to sudden swings driven by the trading of 0DTE options. Traders should proceed with caution and be aware of the risks associated with these short-term options.
