Why You Should Believe In A Santa Claus Rally For Markets

Despite a dismal December so far for markets, there is still a chance for a Santa Claus rally late in 2022, if history is any guide. However, it tends to come late in the month.

Research in the Journal of Financial Planning, found U.S. stocks have historically outperformed between Christmas and New Year, on average, offering a return of around 1% for the final five trading days of the year and the first two trading days of January. That may seem small, but if the markets delivered that consistently, then annual returns for the stock market would be roughly 50% per year.

However, it’s not a sure thing, your chance of an up day for markets during this period is still only a little better than six out of ten based on history. That’s surprisingly good for the stock market, but certainly not enough create a sure thing.

The research examined stock trends for the S&P 500 from 1950-2014 and found similar results for the NASDAQNDAQ
and Russell 2000 indices, but examined a shorter historical time period for those other two markets.

Limitations

Of course, the effect has not worked each year, and outside of the U.S., especially in non-Christian countries, the results are more mixed.

Specifically, the chance of an up day for the S&P 500 during this period is 62% based on history. This implies that the chances of the market rising around the holidays are higher than average, for comparison the chance of the S&P 500 rising on any given day is 53%.

The January Effect

Part of the reason the Santa Claus rally may work is because it overlaps with the January effect. This is the tendency of the market, especially for smaller, value stocks that have been beaten down over the prior year, to rally in the early days of January. That’s one of the strongest calendar effects that researchers know of.

Why It Works

A challenge with these sort of calendar effects, is that you can statistically test for them, but it’s harder to understand why they work. In this case, it’s possible that the effect has something to do with tax-loss harvesting. That’s when investors sell losing investments for tax reasons, often around the end of the year, and then buy back into the markets to improve their short-term tax position. Maybe it has to do with optimism as a new year begins. It could also be related to window dressing as fund managers get their portfolios ready for end of year position reporting. Automated rules for investing to put money to work at the start of the year could also impact market trends during this period. In truth, we don’t know the reason. However, the statistical evidence is reasonably persuasive. It’s also an effect that appears to have persisted, despite widespread research on the topic.

Overall, the markets in will be driven by factors including valuation, earnings trends, recession risk in the U.S. and the path the U.S. Federal Reserve decides to take with interest rates. Still, there’s a good chance based on history that the final few trading days of 2022 and the start of 2023 could prove positive for stocks. That could offer a small edge if history is any guide.