The so-called "Santa Claus rally" refers to the general tendency of the U.S. equity markets to post gains in trading days between Christmas and New Year's Day. The Stock Trader's Almanac extends the analysis a bit, looking at the final five trading days of the year (often starting before Christmas) plus the first two trading days of the next year. This publication finds that, since 1950, the average movement in the S&P 500 Index (SPX) during this period of seven trading days has been a gain of 1.4%, according to CNBC.
This year, bullish investors point not only to this recurring seasonal pattern, but also to the breadth of the current market as reasons for continued optimism. Some bears think that, if Congress fails to make appreciable progress on tax reform before their holiday recess, Scrooge or Krampus will elbow Santa aside, and send the markets downward at year-end. (For more, see also: Top Retail Stocks to Watch on Black Friday.)
Why Santa Comes to Town
Jeffrey Hirsch, author of the Stock Trader's Almanac, has an explanation for the phenomenon of the Santa Claus rally, as reported by FINRA. He finds that individual investors become less active traders during this period, while professional traders and money managers are eager to pick up bargains among beaten-down stocks.
An academic study cited by FINRA suggests that holiday cheer puts investors in an optimistic, bullish mood. The same study also indicates that businesses and governments may be less likely to release bad news during this period, another factor that may spur investor optimism. More interesting still, this study also finds patterns of Santa Claus rallies in Asian countries with small Christian populations, and thus limited Christmas celebrations. The authors, per FINRA, have no precise explanation, but speculate that perhaps these markets are influenced by the direction of stocks in the U.S. during this period.
Sometimes he Leaves a Lump of Coal
As with nearly all seasonal patterns, the Santa Claus rally represents a general tendency, not a sure thing year after year. For example, 15 times since 1950 there have been market declines during the so-called Santa Claus period, sometimes severe ones, according to Hirsch, as cited by FINRA. Notable examples were at the end of 1999, as the dotcom bubble was beginning to burst with a vengeance, and at the end of 2007, with a bear market already underway and the financial crisis just around the corner. Additionally, even in years with Santa Claus rallies, the effect can be dampened by tax-driven selling, especially tax-loss selling.
The breadth of the U.S. stock market advance in 2017 gives cheer to some analysts that this is not a replay of 1999. More than 70% of the stocks in the S&P 500 have posted year-to-date gains, per a November 21 note from Strategas Research Partners cited by Bloomberg. By comparison, in 1999 and 2007 no more than 50% of stocks had advanced.
Chris Verrone, head of technical analysis at Strategas, suggests, per Bloomberg, that another way to gauge market breadth is to compare a capitalization-weighted index with an equal-weighted version thereof. Big gains in big technology stocks, notably the so-called FAANG and FAAMG groups of stocks, have driven much of the rise in the S&P 500 this year. Nonetheless, when Verrone compares the cap-weighted S&P 500 to an equal-weighted version (with each stock representing 1/500 thereof), he finds that the point spread between the two in 2017 is only about 1/4 what it was in 1999, another indicator that today's market gains are much broader. (For related reading, see also: Retailers Take on Amazon for Black Friday.)
Congress May Play Scrooge
Art Hogan, chief market strategist for B. Riley FBR and Wunderlich Securities, told CNBC on November 20 that he expects tax reform debate in Congress to play a major role in whether we see a Santa Claus rally this year. In particular, Hogan, whom CNBC describes as a "longtime bull," thinks that the absence of any notable pullback in stocks so far this year means that the Santa Claus effect will emerge only if there is positive news to propel it, most notably progress on tax reform before year-end. Disappointment on this front, he thinks, would spark a pullback.
The S&P 500 breached the 2,600 mark for the first time ever in intraday trading on November 21. Hogan, in his remarks on CNBC, called for the index to move sideways for the rest of the year, ending 2017 at 2,600. But, contingent on the passage of substantial tax reform, he called for an advance of more than 7% in 2018, to 2,800.