Each year, when the days are at their shortest and retail workers’ shifts are at their longest, market pundits speculate about the likelihood and magnitude of a year-end surge in stock prices.
Dubbed a Santa Claus rally, this phenomenon describes a tendency for the stock market to go up by 1% to 2% over the period spanning the last five trading days of the outgoing year and the first two trading days of the incoming one.
Though not identified until 1972, the trend dates back to at least 1900. It’s unusual to see a bump like this occur so regularly, especially given the efficient market hypothesis—the idea that stock prices incorporate all available information ahead of events expected to impact their prices.
It’s only when outcomes differ from expectations that we tend to see significant price movements: Just look at what happens to stocks during earnings season and after Federal Reserve meetings. Why, then, does the Santa Claus rally seemingly happen about 80% of the time?
Post-Christmas Spending
The Santa Claus rally happens after Christmas, so we can’t clearly attribute it to holiday spending. Still, the period between Christmas and New Year’s, when many people are off work, tends to be busy with shopping activity from returning unwanted gifts, buying unreceived wish-list items and mining year-end sales.
Tax-Loss Harvesting
In early December, investors looking to reduce their taxable gains and rebalance their portfolios often sell stocks that have lost value, a practice called tax-loss harvesting. This large-scale selling, it’s theorized, depresses many stocks’ prices and sets the stage for year-end gains.
Institutional Activity
Some observers posit that the Christmas holiday means fewer large institutional investors are actively trading. But there’s no consensus on how their absence or reduced activity might contribute to a Santa Claus rally.
One theory is that the short selling they would normally do doesn’t happen. Short positions are a sign of bearish sentiment. Without this sign, we get a brief, self-perpetuating burst of bullish activity.
There are a couple of problems with this theory. First, institutional investors aren’t necessarily doing a lot of short selling in the first place. It’s costly and risky. Second, if the Santa Claus period is such a great time to be active in the stock market, it seems unlikely that institutional investors would blow it off. “You know those investment bankers, always on vacation,” said no one ever.
Another theory is that institutional investors—the same ones who are supposedly away from their desks, sipping mulled wine by the fireplace—end the year by gobbling up shares of stocks that have done well to make their portfolios look better, a practice known as “window dressing.” This is the type of predictable activity that should already be priced into an efficient market—if the market is, in fact, efficient, which is up for debate.
Further, window dressing is not a universal phenomenon: It’s a risky practice that’s more common among unskilled fund managers who tend to underperform in both the short and long run, according to research by finance professor Vikas Agarwal and coauthors.
Year-End Bonus Spending and Investing
Another theory is that many corporations hand out annual bonuses at year-end, and all the extra money workers receive gets spent or invested, pushing stock prices up.
The flaw with this theory is that there is no single time of year when most corporations pay bonuses; it varies by company.
For example, bonuses may be calculated after the company’s fiscal year ends and its annual performance can be calculated. And even if a company awards bonuses in December, they might not show up in workers’ paychecks until mid-January.
Believing Makes It So
Human psychology could be at play with the Santa Claus effect, too. People expect stocks to rise and want to benefit from the rally. So they buy stocks, causing them to rally.
If it’s that simple, analysts should do us all a favor and promulgate more calendar effects beyond the presidential election year cycle, January barometer and best six consecutive months.
New Year’s Cheer
The holiday season might have investors feeling more optimistic, especially with corporations and governments reluctant to announce bad news during this period if they can avoid it. In addition, investors who believe in the January effect might hope to bolster their returns by snapping up shares at the end of December that they expect to rise soon thereafter.
That said, plenty of people are miserable during the winter holidays: they’re sick, lonely, exhausted, grieving and cold. Santa Claus rally proponents must assume that these people aren’t checking their portfolios or making trades. Also, the S&P enjoyed a rally over the 2019 to 2020 Santa Claus period despite the news reports that emerged on December 30 about a concerning respiratory virus in China.
Is the Santa Claus Rally Even Real?
Just like other calendar effects in the stock market, observers disagree over whether the Santa Claus rally is valid or useful. If you’d like to draw your own conclusions, here are some additional points to consider.
What Constitutes a Rally?
When Yale Hirsch, creator of the Stock Trader’s Almanac, “discovered” the Santa Claus rally and coined the term in 1972, he was examining the period from 1952 through 1971, during which it had materialized in 17 out of 20 years, bringing an average 1.35% gain to the S&P 500 over the six days—not the seven it became later—comprised of the last four rather than five trading days of the outgoing year and the first two trading days of the new year.
For a year to meet the “rally” definition, returns merely need to be positive. Thus, one can say the market has enjoyed a Santa Claus rally whether the return was 7.2% over that period, as it was in 1974, or 0.0003%, as it was in 2006.
Analytical Rigor
The original Santa Claus rally analysis does not meet basic standards of academic rigor. A study published in the Journal of Financial Planning in 2015 attempted to correct for this lack of rigor by testing for statistical significance. It examined three major U.S. stock indices: the Russell 2000, S&P 500 and Nasdaq Composite.
The study also examined returns in 15 other developed countries, so the total sample included eight countries where a majority of residents identify as Christian and eight where they don’t. The beginning dates vary for each of those indices as well.
This study found that the Santa Claus effect is real. Not only that, but it achieved this finding using a less-generous timeframe that aimed to eliminate the positive influence of a possible January effect. It only analyzed returns for the four or five trading days, depending on the year, between Christmas and New Year’s.
At least two other academic studies, albeit less rigorous ones, have found that no Santa Claus rally exists. Both employed smaller data sets. Differences in analytical methods likely exist among various Santa Claus rally studies as well.
From 1987 through 2016, no evidence of a Santa Claus rally exists in the S&P 500, according to a statistical analysis by Brigid Cami, then a master’s student at the University of Toronto.
When analyzing the statistical significance in the daily returns of the S&P 500 and the Nasdaq over the 22-year period from January 1, 2000, through December 31, 2021, finance and economics professor Jayden B. Patel also found that no true Santa Claus rally ever occurred.
Stock Basket
For the purposes of the Santa Claus rally, the stock market is considered to be the S&P 500, the Dow Jones Industrial Average, and the Nasdaq Composite. All three seemingly exhibit the phenomenon despite representing different parts of the market and having different makeups over the years.
Here’s one possible explanation: The effect comes largely from the outsized returns achieved by the stocks of small firms during this period. That’s what a study covering 1926 to 2014 found.
Seasonal Indicators
The Santa Claus rally is just one of many seasonal indicators Yale Hirsch and other technical analysts claim to have discovered.
Since these indicators could just as easily have been invented or devised in an attempt to identify market patterns, trade profitably on that information, sell techniques to hopeful investors or, in some cases, get famous—at least within investing circles—consider these motivations when deciding how much weight to put on this strategy.
If you enjoy reading the tea leaves, however, you can try trading Santa Claus rallies for fun with money you aren’t relying on for your long-term financial security. Just don’t go into it thinking it’s a surefire way to make a large, quick profit. If it was, we’d all be doing it.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
