Whether you believe in Santa Clause or not, this stock market phenomenon has been edged in investor diaries as one of the many seasonal effects that occur during the year.
Let’s take a closer look at this festive season phenomenon:
What is a Santa Claus Rally
Generally, the Santa Clause rally refers to a sustained increase in the stock market over December leading into the first week of January. However, confusion about the actual dates of the phenomenon, with some saying it’s not the week leading up to Christmas into the new year but the week after Christmas until January. Whether the year-end rally is purely psychological or has fundamental reasons behind it, it has been documented and looked at since the 1970s.
Understanding the rally
How long does the Santa Claus stock rally last?
The rally was first mentioned by the author Yale Hirsch in his famous book the Stock Trader’s Almanac in 1972. Hirsch studied the pattern over the last five trading days and the first two market days of the new year from 1950 to 1971. This is where he discovered that the US Index, the S&P 500, saw an average increase of roughly 1.3% every year. Not only did Yale Hirsch discover this phenomenon, but he also saw that it was an indicator of sorts that would predict what was in store for the stock market in the coming year.
Causes and effects
What Causes a Santa Claus Rally?
There is no definitive cause for the Santa Clause rally, but there are several possible reasons that the stock market sees gains over the festive season, which include:
- Investor behaviour is more optimistic over the festive period.
- Retail investors have more influence on the market as institutional investors are on holiday.
- Investors allocate their year-end bonuses to their investment portfolios.
- Herd behaviour sets in as the Santa Clause rally becomes a self-fulfilling prophecy.
- Investors start buying stocks in anticipation of the other market phenomenon that takes place after the Santa Rally, which is called the January effect.
What Happens Before and After the Santa Claus Rally?
Santa Claus Rally Trading Strategies
Seeing as the Santa Rally is only over a seven-day period, it makes sense to deploy very short-term trading strategies ranging from candle stick patterns, using technical indicators, and high-low price entry, just to name a few. The one strategy we will investigate is more of a swing trading strategy than a focus on the seasonal patterns of the S&P500.
Seasonal trends have been worth their weight in gold over the decades just by looking at the equity clock seasonality chart of the S&P 500 below, the investor can see why. Seasonal trends also referred to as seasonality, open a gateway of opportunity for the optimal time to start investing in a stock, commodity, or even a whole market.
Looking at a long-term swing trading strategy, we can see that there is a strong possibility that the S&P 500 starts to rally from mid-October all the way to the end of December. There is a short-term correction in November until upward momentum returns, which gives another opportunity to engage the market. Traders following the seasonal approach could start building positions from October to December and possibly capitalising on the January effect. But considering the month of January has been proven to be very volatile, traders and investors might reconsider leaving positions open at the start of the new year.
Bottomline
Will the Santa Claus rally happen this year?
The stock market is full of calendar effects and catchphrases, like “Sell in May and Go Away,” which have been proven to be actual market outcomes. In the case of the Santa Clause Rally, stocks generally rise over the defined period 75% of the time and have also proven to be a predictor of the market’s direction for the following year. Considering that the S&P 500 has seen an average gain of 0.9% in December over the last 20 years, the odds might be in the investor’s favour.
The misconception is that investors expect this occurrence to happen yearly, despite considering a change in market sentiment. Still, investors should be aware of these market phenomena throughout the year, and the year-end rally is no exception.
Sources: Investopedia, EquityClock
Disclaimer: Trive South Africa (Pty) Ltd, Registration number 2005/011130/07, and an Authorised Financial Services Provider in terms of the Financial Advisory and Intermediary Services Act 2002 (FSP No. 27231). Any analysis/data/opinion contained herein are for informational purposes only and should not be considered advice or a recommendation to invest in any security. The content herein was created using proprietary strategies based on parameters that may include price, time, economic events, liquidity, risk, and macro and cyclical analysis. Securities involve a degree of risk and are volatile instruments. Market and economic conditions are subject to sudden change, which may have a material impact on the outcome of financial instruments and may not be suitable for all investors. When trading or investing in securities or alternative products, the value of the product can increase or decrease meaning your investment can increase or decrease in value. Past performance is not an indication of future performance. Trive South Africa (Pty) Ltd, and its employees assume no liability for any loss or damage (direct, indirect, consequential, or inconsequential) that may be suffered from using or relying on the information contained herein. Please consider the risks involved before you trade or invest.
