A Santa Claus rally describes a sustained increase in the stock market that occurs in the last week of December through the first two trading days in January.
There are numerous explanations for the causes of a Santa Claus rally including tax considerations, a general feeling of optimism and happiness on Wall Street in the USA and the investing of holiday bonuses. Another theory is that some very large institutional investors, a number of whom are more sophisticated and pessimistic, tend to go on vacation at this time leaving the market to retail investors, who tend to be more bullish.
Several theories exist for its existence, including increased holiday shopping, optimism fueled by the holiday spirit, or institutional investors settling their books before going on vacation.
Regardless of the reason, more than two-thirds of the Decembers dating back to the 1960s have resulted in positive gains for shareholders.
Still, as with many market anomalies, it may just be random and there is no guarantee it will continue into the future.
-Understanding the Santa Claus rally-
A Santa Claus rally is a seasonal phenomenon, according to “The Stock Trader’s Almanac,” a longtime provider of analysis of both cyclical and seasonal market tendencies. According to the Almanac, “…since 1969, the Santa Claus rally has yielded positive returns in 34 of the past 45 holiday seasons – the last five trading days of the year and the first two trading days after New Year’s. The average cumulative return over these days is 1.4%, and returns are positive in each of the seven days of the rally, on average.”
Many consider the Santa Claus rally to be a result of people buying stocks in anticipation of the rise in stock prices during the month of January, otherwise known as the January effect. Also, there is some research that points to value stocks out performing growth stocks in December. Of note, many stockpickers in actively managed mutual funds tend to invest in value stocks.
Financial columnists typically opine on the likelihood of a Santa Claus rally. Some cite economic and technical analysis, and others offer pure conjecture.
-Pros and Cons of a Santa Claus rally-
Chartered market technicians pay attention to cyclical trends and, at times, find ways to exploit historical patterns such as a Santa Claus rally. They tend to do so repeatedly over time and by limiting both the amount of risk and reward they take on via position sizing, stop orders and cutting losses short if positions tend to go against them. These speculators also use technical patterns in particular indexes and carefully determine their planned entry and exit points.
None of this is useful for most investors who do not have the trading experience to manage risk in such short time frames. For buy-and-hold investors and those saving for retirement in 401(k) plans, for example, the Santa Claus rally does little to either help or hurt them over the long term. It is an interesting news headline happening on the periphery, but not a reason to become either more bullish or bearish.
-Santa Claus rally could take stocks higher-
This year was a historic year by pretty much all measures—and that includes the stock market. To those like LPL’s Ryan Detrick, the market’s wild moves in 2020 can be summed up in one word: “Unbelievable,” he said.
“This is going to be the first year in history that stocks were down 30% for the year at one point and managed to finish higher,” Detrick says. “That, to me, summarizes a lot—We’ve never seen a round-trip like 2020.”
Indeed, after a record-fast plunge into a bear market in March, stocks have managed to completely recover and are currently trading around all-time highs, up 14% for the year at Tuesday’s close.
Though stocks of late have traded rather sideways, December is typically a strong month for investors, and some strategists see reason to believe stocks might close out the year on a high note.
-A late December rally?
To be sure, historical patterns don’t always hold up when it comes to the market (that’s been true of 2020 at times as well).
But LPL’s Detrick points out that historically (going back to 1950 for the S&P 500), the latter half of December tended to be strong for investors.
December is usually a strong month for stocks, but Santa doesn’t show until the second half of the month.
Others like Charles Schwab’s chief investment strategist Liz Ann Sonders note that going into 2021, there are two main tail risks: One is that “things are even better than what we expect,” which could create the “possibility of overheating growth, maybe more inflation, and putting the Fed in a pickle in terms of, ‘do they have to back away from this easy policy?’,” Sonders said. “The other extreme would be the opposite: That we built in a pretty positive set of assumptions, and what if several or a bunch of them go wrong?”
-Prepare for a pullback-
Indeed, some on Wall Street are already antsy that the markets have gotten overheated and a sell off—or at least pause—might be in the cards.
One big theme many strategists noticed this year was its eerie similarity to the 2009 bull market. And according to some strategists, that map could be signaling some turbulence ahead.
“No one knows if the roadmap will continue into 2021, but if it does, the latter half of January looks a bit worrisome,” Charles Schwab’s vice president of trading and derivatives Randy Frederick wrote in a recent tweet.
But even if 2021 doesn’t continue to follow the 2009-10 map, LPL’s Detrick believes some of the “record run” of the past several months in the market “might be stealing, if you will, a little bit from some of the gains next year,” he says, pointing to valuations as one of the “biggest concerns.” He thinks something like a 10% correction would make sense in the 1st quarter of 2021, and suggests investors consider rebalancing with moves up or down.
But in the meantime, Schwab’s Sonders believes investors can glean a pretty big lesson from 2020 heading into next year: “I don’t think the market should rest on an assumption that the Fed is always going to have the market’s back,” she says.
“When we get the next correction—and we’ll get one, I don’t know when—if it doesn’t threaten financial systems stability, if it’s not crisis-driven, I don’t think we can rely on the so-called ‘Powell Put,’ that the Fed’s just always going to be there,” Sonders says. “We have to be mindful of that in 2021.”
-Wikipedia-
A Santa Claus rally is a calendar effect that involves a rise in stock prices during the last 5 trading days in December and the first 2 trading days in the following January.
According to the 2019 Stock Trader’s Almanac, the stock market has risen 1.3% on average during the 7 trading days in question since both 1950 and 1969. Over the 7 trading days in question, stock prices have historically risen 76% of the time, which is far more than the average performance over a 7-day period.
However, in the weeks prior to Christmas, stock prices have not gone up more than at other times of the year.
The Santa Claus rally was first recorded by Yale Hirsch in his Stock Trader’s Almanac in 1972.
The Dow Jones Industrial Average has performed better in years following holiday seasons in which the Santa Claus rally does not materialize.
-The Bottom Line-
According to Barrons, trading in the period after Christmas is not recommended. There is little upside and, as of 2017, the market fell in the two of the three prior years. Moreover, if there is no rally, that can be a sign of a bear market in the future. In the final weeks of 1999 and 2007, stock prices rose rapidly but only to be followed by bear markets. A better strategy is to maintain a long-term investment strategy and not be tempted by the promise of Santa Claus rallies or January effects. ♦
