Yes, there really is a Santa Claus rally
Young children and passionate seasonal investors should avert their eyes now, for the question must be asked: does the Santa Claus rally exist?
The Christmas period has long had a reputation as a source of seasonal cheer for stock market investors. December has historically been the most wonderful time of the year for investors, sporting better returns and more monthly gains than any other month.
As far back as 1942, academics were debating whether the Christmas feel-good factor might be driving stock markets higher, a theory that gained popular currency in 1972, when Stock Trader’s Almanac publisher and market historian Yale Hirsch coined the term “Santa Claus rally”. Over the last 120 years, US stocks have gained over the Christmas period three-quarters of the time, with gains roughly 10 times that seen in a typical period of similar length.
Unusually strong returns have apparently persisted since the almanac “discovered” the phenomenon 45 years ago.
“Santa Claus tends to come to Wall Street nearly every year, bringing a short, sweet, respectable rally within the last five days of the year and the first two in January,” according to the 2017 Almanac. “This has been good for an average 1.4 per cent gain since 1969.”
Although the data appears compelling, the idea of a Santa Claus rally is often dismissed as a myth or a fluke, sceptics noting that the Almanac makes no reference as to whether the results are statistically significant or evident in non-US markets.
S&P Dow Jones Indices analyst Tim Edwards says the Santa rally is real and is global. After examining 12 international indices over the 1994-2014 period, he found there was an above-average “Santa score” in every single market. Nevertheless, S&P’s analysis looked at December as a whole, rather than isolating the Christmas period, so it may have been premature in saying “the evidence supports the existence of a ‘Santa Claus rally’”.
However, the title of a 2015 study published in the Journal of Financial Planning, Yes, Virginia, There is a Santa Claus Rally: Statistical Evidence Supports Higher Returns Globally, confirmed what believers have long preached. It examined Christmas and new-year returns for 18 indices in 16 different countries, including countries where Christmas is not the leading holiday, such as Japan, Singapore, India, Indonesia, and Taiwan. Overall, global investors enjoy much bigger profits at this time of year: both large- and small-cap stocks experience “significant rallies”, translating to annualised returns of “about 50 per cent”.
Daily returns were positive 63 per cent of the time, compared to just 53 per cent of days outside of Christmas. Above-average returns were evident in all 18 indices and the results were statistically significant in 14 cases.
A fluke? Unlikely. A number of calendar effects and fundamental factors support stock prices at this time of year. The authors of the above study point to the so-called January effect. Academics have long noted that January has historically tended to generate above-average stock returns, with much of the excess returns concentrated in the first few trading days of the year. The Santa rally appears less impressive if the first two days of January are excluded, according to the researchers, indicating the Santa rally “may be picking up a partial January effect”.
Secondly, there is the turn-of-the-month effect – the tendency for markets to be very strong at the beginning and end of months. One study found this calendar anomaly to be evident in 30 out of 34 countries. In fact, almost all US market returns in the 20th century were concentrated in this narrow window of the calendar.
“In other words,” notes Nobel economist Richard Thaler, “aside from the four days around the turn of every month, the DJIA [Dow Jones Industrial Average] fails!”
Then there is the pre-holiday effect – the tendency for indices to rise in advance of holidays. One 1990 study found that US returns on the trading day before a holiday were, on average, 14 times greater than that seen on the other days of the year. Subsequent US research has cast doubt on these early findings, although the pre-holiday effect has been documented in a number of international markets.
Of course, the most common explanation is that investor sentiment tends to be elevated at this time of year. “You see a lot of optimism about the new year, and that gives stocks a boost in December,” said State Street Global Advisors earlier this month. That’s echoed by the authors of the Yes, Virginia study, who suggest investors “may be more optimistic during the Christmas holiday season, and their optimism might cause them to be bullish on stocks”.
A host of other potential triggers – end-of-year bonuses being invested, tax considerations, short sellers being on holidays, window-dressing by fund managers who buy top-performing stocks so that they can pretend they have been holding the winning stocks all along – are also cited by commentators.
In other words, a confluence of factors means that, more often than not, stock prices get a nice little jolt higher around the Christmas and new year period. Since 1950, notes LPL Research, the seven days that constitute this period have been stronger than all but one other seven-day period in the calendar.
For short-term traders using leveraged products, it makes sense to typically adapt a bullish bias over Christmas, say the authors of the Yes, Virginia, study. Of course, leverage “is a double-edged sword”, magnifying gains but also intensifying losses. “In practice, few planners would encourage their clients to dive into stocks or an E-mini futures contract at the beginning of the rally and then exit at the end of the rally.”
Stocks tend to rise in both holiday and non-holiday periods, so it’s not wise to jump in and out of investments. Still, they suggest that, if you are about to purchase stocks, it may be more prudent to do so prior to Christmas rather than waiting until early January. Similarly, if you’re about to sell stocks, it might be wise to hold off just a little bit longer.
Of course, Santa doesn’t always descend on Wall Street. The Stock Trader’s Almanac suggests a failure to stick to the seasonal script can be an indicator further short-term pain is in store – hence the expression, “If Santa Claus should fail to call, bears may come to Broad and Wall.” They point to 1999 and 2007, when poor Christmas periods were witnessed just prior to two savage bear markets; to 2004, when the Indian Ocean tsunami derailed any seasonal cheer; and 2015-2016, when indices were battered by China-induced worries and stock markets suffered their worst-ever start to a year.
More often than not, however, Santa doesn’t forget investors. The data is clear: yes, Virginia, there is a Santa Claus rally.