The “Santa Claus Rally” is a fabled market term used to explain the rise in equity markets often experienced at the end of a year. It consists of the last five trading days of the year and the first two trading days of the New Year. Over the past 50 holiday seasons, the S&P 500 has had positive gains in 40 of these periods with and average return over 1.4%1.
In fact, the chart below shows that December has been the third-best month of the year for the S&P 500 going back to 1928. Here are some of the more common theories that explain the Santa Claus Rally:
The “January Effect”: This refers to the seasonal tendency for stocks to rise in January. Traders could be buying stocks in anticipation of this effect.
Adjustments: Investors often adjust their portfolios for taxes and rebalancing towards the end of the year.
Window dressing: Big institutional investors (banks, mutual funds, pensions, etc.) have been known to make big purchases before year-end in stocks that performed will during the year. That way, when it comes time to report holdings to their investors, it looks like they’ve had large positions in big winners all year long (yes this actually happens).
Bonuses: Year-end bonuses get paid, and these tend to get invested quickly when markets have been performing well.
Will it to happen: So many traders expect a Santa Claus rally that their synchronized activity becomes a self-fulfilling prophecy.
History seems to support the validity of a Santa Claus rally, but before the excitement of a jolly old man bringing stock gains to all the good boys and girls overcomes our cognitive defenses, let’s play devil’s advocate because a very compelling bear case could also be made. Consider these:
Already up: The stock market has already surged this year, so traders may choose to sell and lock in gains before the New Year.
More variants: Omicron or any other COVID scare could surprise us.
Recent volatility: The S&P 500 has been on a wild ride since Thanksgiving, and volatility often begets more volatility.
Geopolitics: China invades Taiwan, Iran’s nuclear progression, Russia vs. Ukraine, etc.
End of the World: The late pastor F. Kenton Beshore prophesized before his death that 2021 is the beginning of the end. If so, there may be a flight to safety prior to the start of the seven-year tribulation period that will be characterized by “devastating events like asteroid hits, earthquakes, volcanic eruptions, and giant tsunamis”2.
Simply put, no matter how long the list of reasons to support a Santa Claus rally, the list for why the exact opposite could occur is just as long.
The Bottom Line
Stocks rise and fall over the span of a few days for countless reasons. Isolating these factors and then using them to predict the near-term direction of the stock market feels too much like alchemy.
On the flip side, only a handful of drivers move stocks over the long run - revenue, earnings, cash flow, dividends, etc. These fundamentals can be observed, measured, and sometimes even forecasted.
For example, if Apple’s stock price rises dramatically over 2-3 days, it’s doubtful that the fundamentals have changed much. Apple is a huge company, and fundamental shifts tend to be migratory rather than immediate. The move could be due to several catalysts completely unrelated to the company. But if Apple’s stock rises slowly over 2-3 years, there is likely only one reason - they are selling more iPhones, iPads, and other high-margin products that often not-so-coincidentally break two days after their warranty expires.
Since forecasting near-term returns is mostly impossible and irrelevant to long-term performance, my strategy this holiday season is going to be simple. I plan to do nothing at all.
If a Santa Claus Rally does happen, then it will be the cherry on top of another great, albeit weird year for equities. If stocks sell off, then I’ll likely go discount shopping for deals that are too good to pass up.
The bottom line is that a Santa Claus rally makes for good banter on financial news networks, but it should have no bearing on the long-term direction of stock prices.
Sources
1Bloomberg, Darwin Asset Management analysis
2 https://www.ibtimes.co.in/end-world-deceased-pastor-left-behind-chilling-warning-2021-831731
Disclosures
This material has been prepared for informational purposes only and should not be construed as a solicitation to effect, or attempt to effect, either transactions in securities or the rendering of personalized investment advice. This material is not intended to provide, and should not be relied on for tax, legal, investment, accounting, or other financial advice. You should consult your own tax, legal, financial, and accounting advisors before engaging in any transaction. Asset allocation and diversification do not guarantee a profit or protect against a loss. All references to potential future developments or outcomes are strictly the views and opinions of Richard W. Paul & Associates and in no way promise, guarantee, or seek to predict with any certainty what may or may not occur in various economies and investment markets. Past performance is not necessarily indicative of future performance.