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Will ECB Light Way for Santa’s Sleigh?

The European Central Bank is distributing plenty of gifts to the continent’s financial system, but advisers warn it may squash hopes for a year-end rally.

This morning, the ECB reported record demand from banks for new three-year loans, meaning they gave out the most money they’ve ever distributed in a single refinancing operation. At first, the euro rallied and U.S. stock futures rose, but the trend quickly turned around. Analysts say that even though markets had welcomed the news that the ECB would be offering these loans, the stronger-than-expected demand appears to be worrying traders, because it suggests banks are desperate for cash. “The fact that 523 banks used the facility suggests that the system may be weaker than previously anticipated,” Christopher Vecchio, a currency analyst at DailyFX, wrote in a note to clients this morning.

In fact, many advisers say the move may dim hopes of a year-end rally. The market’s mood tends to brighten in December, in what’s known on Wall Street as the “Santa Claus effect.” Stocks have risen in the fourth quarter nearly four out of five times since 1945, according to Standard & Poor’s Capital IQ. And over that same time period, the S&P 500 index has gained an average 7.2% in the fourth quarter, following an average 10% drop in the third quarter — similar to what we saw this year. So far this month, stocks are down just under 1%.

And even though the Dow rose more than 300 points Tuesday, many pros remain defensive. Adviser Paul Nolte, the managing director of Dearborn Partners, for example, suggests investors come up with lists of stocks they want to buy and sell and the prices they’d like to see, and wait for choppy markets to swing through those prices. Be prepared to sell some stocks on days when the market’s rallying, and look for buying opportunities on down days, he says. “Until proven otherwise, it’s still a defensive market,” he says, so investors should be looking to reduce their exposure to the sectors that are most vulnerable to economic downturns (like industrials or consumer discretionary stocks) and increase their exposure to more stable areas like consumer staples, health care, or blue-chip tech stocks.

It’s unclear if the ECB’s efforts will do much to quell this volatility, analysts say. The central bank has repeatedly said it won’t simply buy up European government bonds the way the Federal Reserve bought up bonds in its quantitative easing programs. Instead, it is lending banks a lot of money at cheap rates so that the banks can buy the bonds—a strategy some say doesn’t address the underlying problems. “It’s like you and me saying we’d like to have a billion dollars apiece: You agree to lend me a billion and I agree to lend you a billion. It literally is a big circle,” says Bob Phillips, a managing principal at Spectrum Management Group, a financial management firm. “It doesn’t fix the problem, but it buys them time” to work on a political solution to sovereign debt levels, he says.

And if European banks are even weaker than investors feared, the 489 billion euros the ECB loaned out on Wednesday may not actually buy very much time, Nolte says. That may mean volatility will continue for the rest of the year, a change from the traditional year-end pattern of relatively calm and cheerful markets, Nolte says. “Unfortunately, I don’t think the volatility goes away,” he says.

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