What Is a Santa Claus Rally?
A Santa Claus rally describes sustained increases in the stock market that occur 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 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.
Financial columnists typically opine on the likelihood of a Santa Claus rally. Some cite economic and technical analysis, and others offer pure conjecture.
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. In 2017, Seeking Alpha quoted the almanac, saying, "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 outperforming growth stocks in December. Of note, many stockpickers in actively managed mutual funds tend to invest in value stocks.
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 401k 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.
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.