The significance of the Christmas holiday extends beyond its religious and commercial dimensions.
While it holds cultural importance as a time for exchanging gifts, it also plays a notable role in the financial realm, particularly in the stock market.
This is because historical data suggests that Christmas can lead to substantial volatility and even market rallies. This phenomenon, commonly referred to as the 'Santa Rally,' has caught the attention of investors.
Accordingly, in this article, we explore the impact of Christmas on stock markets, explain what a Santa Rally is and how you can trade in case of a Santa Rally, and delve into the historical patterns and underlying factors that can contribute to this market event.
What Is a Santa Claus Rally?
A Santa Rally refers to a tendency of markets to move higher in the final couple weeks of the year, leading up to Christmas. There is some debate on the exact time frame of what constitutes a Santa rally, whether it's in the week before Christmas or the week after, and whether it includes the first two days of the new year.
The week after Christmas is known to be especially quiet, with markets typically range-bound with low trading volume. Many traders take the holidays off, and market makers would be expected to make year-end position adjustments while ample liquidity remains after Christmas.
What Causes a Santa Rally?
Although the reasons behind a Santa Rally aren’t known for sure, there are abundant theories to explain the phenomenon.
One explanation is that traders are imbued with more positivity because of the holiday spirits.
Another one is that institutional investors typically take time off for the holidays, leaving markets in the hands of retail traders who tend to be more bullish.
Similarly, many people get holiday bonuses and might want to put a little extra into their savings, such as mutual funds.
Another consideration is taxes, as investors balance their books ahead of the close of the fiscal year to optimize their tax position, which is known as the “January Effect.”
Portfolio managers may also want to "dress up" their holdings, buying up assets that had performed well during the year to make their positions look more attractive.
Who Coined the Term “Santa Claus Rally”?
The term "Santa Claus Rally" was introduced in 1972 by Yale Hirsch, the founder of the trading guide, "The Stock Trader's Almanac."
Hirsch scrutinized market trends and identified a phenomenon during the last five trading days of one year and the initial two trading days of the subsequent year whereby stocks experienced a surge of over 79%, propelling the S&P 500 (USA 500) to new heights.
Furthermore, The Stock Trader’s Almanac looked at data spanning from 1950 to 2020 and concluded that a Santa Claus Rally occurred 57 times in this period and that this pattern was accompanied by an average growth of 1.3% in the S&P 500.
What Is the January Effect?
The January Effect is a phenomenon characterized by a perceived seasonal upswing in stock prices during the month of January.
This trend is often attributed to more buying activity, driven by the anticipation of a rise in stock prices that month. The initial two trading days of January are typically encompassed within this upward movement.
Certain studies suggest that, in December, value stocks have a tendency to outperform growth stocks. This can be attributed to investors engaging in tax-loss harvesting, along with the repurchase of stocks or the allocation of year-end cash bonuses into the market.
Therefore, for some investors, January represents a good time to initiate an investment program or to act on New Year's resolutions related to financial goals.
How Do You Trade During a Santa Claus Rally?
To trade during a Santa Rally, consider conducting a thorough analysis of historical price patterns to pinpoint strategic entry and exit points.
Additionally, you may want to monitor risk-reward ratios and implement stop-orders to safeguard your position in case the market moves against your predictions.
Finally, creating a trading plan and strategy and setting stop-loss levels, and plans for scenarios where the trade neither yields profits nor triggers a stop-order by the Christmas deadline can be helpful.
This proactive approach can enhance your ability to navigate the uncertainties of the market during the festive season.
Is Santa Claus (Rally) Real?
Since there is little consensus on the cause of the effect, it is natural to think that traders are seeing a pattern that isn't there. However, historical records show that markets tend to overperform in this period. Since 1950, the S&P 500 has clocked in an average gain of 1.3% during the last week of the year and the first two days of the new year. During last year’s “Santa Rally,” for example, the S&P 500 gained 0.8%. (Source: The Wall Street Journal)
Additionally, while there is no guarantee that a Santa Rally will occur every year, the odds may seem favorable historically. Since 1950, the S&P 500 has risen almost 70% of the time during the last week of December.
Could There Be a Santa Rally in 2023?
Whereas past performance does not reflect future results, it seems that many analysts believe that a Santa Claus Rally may be “in the cards for 2023.” According to analyst Brooke Thackray, “it’s very bullish for the markets right now on a seasonal basis”. (Source: Yahoo Finance)
On the flip side, those who are bearish claim that macroeconomic pressures from factors like high inflation, the Fed’s hawkishness, a strong US dollar, rising oil prices, and geopolitical tensions can all lower the possibility of a rally this year.
As such, only time will tell what this holiday season will usher forth.
Where Could the Economy Be Headed in 2024?
Several factors that could capture the attention of traders and investors during this holiday season extend to the anticipated trajectory of the global economy in 2024.
All of these factors can also shift the trajectory of holiday sales and consumer sentiment. In addition, the Federal Reserve (FOMC) is expected to meet for the final time in 2023 on December 12-13 during which it will decide on interest rates, which can also influence the trajectory of the economy.
Wrap It All Up
A Santa Rally refers to the average rise in stocks at the end of the year, which happens more often than not. However, conditions at the end of each year can cause results to deviate from the norm.