What Is a Santa Claus Rally?

How Does A Santa Claus Rally Work?

A Santa Claus rally is a market rally that causes stock prices to increase during the holiday season, typically a seven-day period beginning the day after Christmas and ending on the second trading day in the New Year.

According to data compiled by Stock Trader’s Almanac in the 70 years between 1950 and 2020, a Santa Claus rally has occurred 57 times and has, on average, seen the S&P 500 go up by 1.3%. The S&P 500 was introduced in its current form only in 1957. Between 1926 and 1950, it existed as the Composite Stock Index, tracking 90 stocks.

Example of A Santa Claus Rally

An example of a big Santa Claus rally occurred in December 2008 going into January 2009. A seven-trading day period starting Dec. 24, 2008, and ending Jan. 5, 2009, saw the S&P 500 gain 7.36%. This rally brought some respite to the index that had, until then in the year, dropped more than 40%.

Why Does A Santa Claus Rally Occur?

There are many explanations for why Santa Claus rallies occur, but it is hard to pinpoint the exact reasons.

Some analysts believe that it’s caused by the completion of tax-loss harvesting. Professional investors often adjust their portfolios at the end of the year for tax purposes by selling stocks at a loss. That temporarily pushes down stock prices, but that trend is soon reversed as investors begin buying stocks again, pushing prices higher.

There’s also the argument that holiday shopping can bolster businesses’ bottom lines and help boost stock prices. Also, many employees receive year-end bonuses that can be invested in the market. Some of the theories that aim to explain both the Santa Claus rally and the January Effect have received criticism.

Some researchers believe one reason for the Santa Claus rally is bullish investors’ sentiment as people are generally optimistic around the holiday season. The unlikeliness of the government or regulators announcing any bad news during the holidays may be the driving force behind this optimism.

Regardless of the mechanics behind the rally, it’s an observable effect and it occurs roughly two out of three years, so investors should be prepared to see whether Santa shows up at the end of each year.

Some investors use the existence of Santa Claus rallies as indicators for the coming year. If there’s a Santa Claus rally to end a year, the next year is expected to be good. If the rally fails to appear, the next year will be poor.

For example, according to data compiled by LPL Research and FactSet, the Santa Claus rally period in 1999 saw the S&P 500 drop 4% and the Dotcom bubble burst in 2000. Similarly, corresponding trading days in 2007 saw the S&P 500 drop 2.5%, and 2008 saw the Great Recession.

A fun phrase that Yale Hirsch also coined to describe how a lack of a Santa Claus rally will affect the market is “If Santa Claus should fail to call, bears may come to Broad and Wall,” referring to the Wall Street location of the New York Stock Exchange.

Interestingly, the Santa Claus rally is observed in stock markets around the world. For example, the Indian stock market exhibits a similar effect, where the last five trading days of December and the first two trading days of January tend to produce higher average returns than other days.

What It Means for Individual Investors

How the Santa Claus rally impacts individual investors will depend on their investment goals and style.

Many individuals will see the most benefit from long-term investing in diversified mutual funds. The Santa Claus rally does create high returns in these investments, but it generally isn’t worth changing your entire investment portfolio for the month of December to try to take advantage of the rally if you’re a passive investor planning for the long term.

More active investors, however, may want to make their portfolios more aggressive to try to make the most of the rally and use the appearance (or lack thereof) of the rally as an indicator for how to invest in the year ahead.

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