Markets may be experiencing a little bit of volatility currently but Saint Nick is right on schedule to save everyone’s portfolio this season. The S&P 500 is down roughly 3% this past month heading into Christmas where investors are once again hoping for a little Santa Claus Rally.
What is the Santa Claus Rally?
The Santa Claus Rally is a phenomenon where the stock market often rises during the last week of December and first two trading days of January. The rally doesn’t happen every year but occurs more often than not and even occurred last year although on a relatively small scale.
Why Does the Rally Occur?
There are various theories for why stocks typically perform well following Christmas but the general consensus is that it’s a collection of simple factors. Tax considerations, holidays bonuses (as well as gifts of cash), and general happiness/optimism during the season on Wall Street often are used to describe the rally.
The other, more interesting, analysis for why a rally occurs around the new year is that institutional investors often go on vacation around this time. Thus, retail traders, who are often more bullish, influence the market more than the “normal” trading season. Additionally, some believe that the January Effect, a perceived increase in stock prices during January, leads to investors buying stocks in anticipation of prices rising.
What Do the Numbers Say?
According to the 2016 Almanac, the last week of December and first two days of January have experienced positive returns in 34 of the past 45 years. The average return over those days being 1.4%. At that rate, a full year of the Santa Claus Rally would lead to stocks rising more than 50%, safe to say a decent bit higher than usual.
Will There Be a Rally This Year?
The most important question is whether a rally will occur again this year. Without any further analysis, just betting on a rally has a pretty good success rate at 75% according to recent patterns. Clearly markets enjoy a strong trading period during this time more often than not, and recent trading may suggest there’s even a greater than 75% chance of stocks rallying.
Major indices have pulled back across the board recently with the S&P 500, NASDAQ, Dow Jones, and others retreating from highs. This downturn in December is often explained by tax-loss harvesting but other factors such as the Omicron variant and likely failed infrastructure bills also explain the bearish turn. These combined with high inflation numbers have led to stocks falling recently.
Thus, this small dip may just come at the perfect time where investors are ready to buy back following Christmas with renewed optimism. A little dip in prices right before investors expect a rally is probably going to lead to increased optimism over fears of continued woes, especially when value stocks typically outperform growth stocks during that time.
A new coronavirus variant is the most likely to cause any kind of long-term bearish view on markets but while the Omicron appears highly infectious, it also appears to be far less lethal than previous strands. Meanwhile, infrastructure bills can always be reworked or just pushed back farther again. Lastly, high inflation numbers and supply chain shortages are certainly top priorities for the Fed and are of central concern to many investors. These not so temporary price pressures are not great for the economy, but most people don’t take their money out of markets and under the bed when they fear that pile of cash is going to be worth a lot less in a year than it is today.
There’s no certain way to know if a Santa Claus Rally will occur again this year, but history suggests it's very likely and a small dip heading into the best seven days of trading should only increase optimism of a rally.
