What is a 'Santa Claus Rally'

A Santa Claus rally is a move higher in the stock market that occurs in the last week of December through the first two trading days in January.

There are numerous explanations for what causes a Santa Claus rally, including tax considerations, happiness around Wall Street and people investing their holiday bonuses. Another is that some very large institutional investors, a number of which are more sophisticated and pessimistic, tend to go on vacation this week, leaving the market to retail investors, who tend to be more bullish.

Of note, many financial columnists usually write stories about why they believe a Santa Claus rally will or won’t happen every December, mostly citing economic and technical analysis or, in some cases, conjecture.

BREAKING DOWN 'Santa Claus Rally'

A Santa Claus rally is indeed a seasonal phenomenon, according to The Stock Trader’s Almanac, a longtime provider of  analysis of both cyclical and seasonal market tendencies.

Looking at data from 1950 to 2017, the Stock Trader's Almanac found that the S&P 500 Index advanced in 49 Decembers and declined 17 times, with an average gain of 1.6%, the best for any month.

The scorecard for the Dow Jones Industrial Average (DJIA) looked similar: up 46 times, down 20 times, and an average gain also of 1.6%.

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’s 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 Santa Claus rallies. 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. They 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’s an interesting news headline happening on the periphery, but not a reason to become either more bullish or bearish.

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