Santa Rally: Fact or Fiction?
The benchmark of US equities, the S&P 500 (USA 500), is down about 17% so far this year. Historically, when stocks underperform, bonds do better, but this year bonds underperform, with Bloomberg’s bond aggregate index down 11%. That means investors could be pleased to see some rally at the end of the year. And history says that could happen in a "Santa Claus Rally", where stocks typically outperform at the end of the year. In the case of a Santa Rally, investors should probably not expect the rally to last all year since it tends to be a short-term phenomenon and prefer to prepare for a potential pullback in early 2023. (Source:CNBC)
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?
It isn't known for sure, but there are abundant theories to explain the phenomenon. A simple 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.
Other considerations are taxes, as investors balance their books ahead of the close of the fiscal year to optimise their tax position. 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.
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. But, 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. Last year’s “Santa Rally” saw an even better performance, with around a 5% gain in the US benchmark index.
While there is no guarantee that a Santa Rally will occur every year, the odds may seem favourable 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 2022?
As the saying goes, past performance doesn't mean future results. Santa rallies take place about two-thirds of the time. However, many investors might be upbeat about the prospects for this year after US CPI came in lower than expected on Tuesday, December 13. Although they express caution about not reading too much into a single data point, some analysts suggest that it implies that the chances of a soft landing have improved, which could support investor sentiment. (Source:Yahoo Finance)
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 debate from the norm. With the Fed expected to continue hiking interest rates next year but better than expected CPI figures, markets may at least be approaching the period with some newfound optimism.