The Santa rally or Santa Clauss rally is a well-recorded phenomenon in which stocks tend to rise in the last week of December. It has become a regular market phenomenon, that investors and traders are well aware of.
The Santa rally usually occurs during the last five days of December and the first two days of January.
The term was coined in the early 1970s by a stock market analyst who identified the trend that had built up around this time of year.
It is named due to the Christmas period over which it occurs and the perceived potential gifts awaiting investors who make the most of the opportunity.
There are a number of theories as to why the Santa Claus rally continues to happen. However, no consensus has been reached amongst traders or analysts on what the primary factor or factors are.
Is the Santa rally for real?
It can’t be guaranteed to occur with certainty in any given year and we can’t be sure what the cause or causes of the Santa Claus rally are. However, the statistics show that the seasonal phenomenon is definitely real.
Going back to the 1960s, more than two-thirds of the December months have resulted in positive gains for shareholders. Whilst the most skeptical of observers might say that this is still possibly random as with many market anomalies-
The “Stock Trader’s Almanac” has pointed out that in 34 of the past 45 holiday seasons going back to 1969, the Santa Claus rally has yielded positive returns. This percentage of over 70% is significantly higher than an average week taken in those years.
The Almanac website, based on a well-respected book from the 1960s, says “The average cumulative return over these (Santa Claus rally) days is 1.3%, and returns are positive in each of the seven days of the rally, on average."
In the long run, there are few anomalies in the investing world that can provide such consistent returns in the long run. However, it’s still important not to fall into the trap of believing that just because something has happened consistently in the past that it will definitely happen again.
Will there be a Santa rally every year?
Anyone who says that they know for certain what will happen is unlikely to be a good source of trading insights. Many analysts will make predictions on the likelihood of the Santa rally happening, although they might not be accurate. It is usually those who are most comfortable with expressing their uncertainty who have the most astute advice to offer according to Superforecasters authors Philip E. Tetlock and Dan Gardner.
Whilst the Santa Claus rally provides us with some insight on the predictability of one week in comparison to others throughout the year, historical probabilities of around 70% make it hard to say with confidence what will happen next. Predicting the stock market accurately is nearly impossible.
Predicting the Santa rally trend remains even more difficult as long as we continue to not know what the causes of it are.
What causes the Santa Claus rally?
There are a number of ideas that have been thrown out over the years on what causes the Santa rally:
Institutional investors on vacation
This time of year is a unique one for trading since institutional investors are usually on vacation at this time. They tend to be more pessimistic with their investments, although they are considered to be the most sophisticated at their craft in the long run. Retail investors on the other hand are generally more bullish and optimistic. Having the market’s reins be taken by people other than institutional investors for a week is often cited as a cause of the seasonal phenomenon.
Optimism
Another theory is that it is a time of year when people are particularly optimistic and so this holiday spirit results in more optimistic trading. If this is one of the causes, it will likely remain a tough one for analysts or investors to verify any time soon due to the difficulty of measuring phenomena such as Christmas spirit or traders’ optimism.
Holiday investing
It’s also been theorized that people tend to invest their holiday bonuses, leading to influxes of cash into the market and an increased likelihood of a temporary bounce. This could potentially be measured one day by comparing bounces (or lack of) in markets when large groups of people get bonuses at other times of the year. This may require looking into other trading cultures outside of the West.
In all likelihood, it is likely to be a mixture of factors that causes the Santa Claus rally. This makes it even more difficult to predict since even if we were to verify which factors did have an impact, it would then have to be calculated to what extent each one plays a part. This is why predicting a Santa Claus rally in any given year remains difficult. Even if you can say with some confidence how many times it will occur in the next decade or more.
As time goes on, the phenomenon itself continues to be confirmed as real to the few non-believers who remain. However, it will possibly take many more years of data to work out exactly what drives it.
Alongside this, systematic analyses that compare the given week over Christmas with other weeks and possible trends in various markets will probably be required. Until anyone can answer what causes the Santa Claus rally with any confidence.
Should I buy stocks before or after Christmas?
The data seems to suggest that buying stocks before Christmas is likely to be a good decision. The market is expected to go up, due to the Santa rally.
History suggests that if you have to consistently buy stock to hold for a week at any time of year, Christmas may be the best time to do so in the long run. However, there is not enough information on the topic to reliably profit from this in any given year.
Conclusion
The Santa rally is a known stock market phenomenon that seems to correlate well with the January effect. It is also one of the reasons why it has become profitable to invest in stocks before Christmas and to sell them in late January, or early February.
Despite the fact that there is enough historical data to prove these movements, that does not mean that they will happen every year. As an investor, you should not base any investment decision based on this.