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5 Reasons to Believe in a Santa Claus Rally

Most investors believe the stock market performs quite well in December, with the so-called “Santa Claus” rally lifting stocks.

But is this seasonal strength a reality, or just a market myth?

And even if a Santa Claus rally does lift the market most Decembers, what guarantees do we have that this will be an up year based on the current market challenges?

If you’re one of the doubters who thinks the market might run out of gas, here are five reasons to believe in a big December rally for stocks:

December Is Mostly a Winner: Some say the seasonal strength is thanks to increased activity as institutional investors trying to juice returns before year-end or simply rebalancing before the end of the tax year. Others think it’s just the happiness of the season giving Wall Street a positive vibe. But whatever the reason, there’s strong historical evidence that December is a good month for stocks. In the 63 years dating back to 1950, only 16 Decembers haven’t resulted in gains for the S&P 500 — a 74% winning percentage. Since 1970, the S&P is 35-of-43 in December — that’s an 81% record of gains.

Santa Claus Gains Are Big Gains: Don’t think that it’s just a tiny gain investors have tallied in December, either. According to the Stock Trader’s Almanac, December’s raw performance is the best of the 12 with average returns of 1.7% for the S&P 500 since 1950. And since 1970, those gains have averaged 2.3%.

Retail Investors Are Getting In: U.S.-based stock funds already sit at a record $235 billion in inflows this year. Now, some folks see this as the ultimate sign of a top as retail investors jump in just in time to get fleeced … but keep in mind that January 2013 saw massive money inflows to stocks, and that wasn’t cold water for the market but more fuel for the fire.

Multiple Expansion Continues: Say what you want about the rather modest earnings growth for most companies, but the biggest reason the market is rising is multiple expansion. I’m talking about earnings multiples, of course, or the price that a stock trades at relative to its profits — most commonly tracked by P/E ratios. The bears love to tout high price-to-earnings multiples as sign of a crash, but historically, multiple expansion is actually a bullish sign as investors are willing to pay more for future cash flows.

Taper Talk Is No Biggie: Many investors insist that the “tapering” hinted at by the Federal Reserve is the biggest risk to the market. After all, easy-money policies like quantitative easing and low interest rates have punished savers and pushed a ton of capital into the stock market — so a reversal would be painful. However, with inflation no big deal and unemployment still significantly above the 6.5% target mentioned last year by the central bank, the Federal Reserve is highly unlikely to tighten up anytime soon. Also, soon-to-be-Fed Chair Janet Yellen has shown how dovish she is by asserting that  “Monetary policy is likely to remain highly accommodative” even if things continue to improve. In other words, if you’re expecting a Fed move in the next few months … you’re mistaken.

More on the Santa Claus Rally

Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not own a position in any of the stocks named here. Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP

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