In the last week of December a strange phenomenon takes place on the stock exchange when the price of stock tends to surge. Whether fuelled by Wall Street festive cheer, end-of-year bonus investments or short sellers being on holiday no one is entirely sure.
Coined the Santa Claus rally by market analyst Yale Hirsch in 1972, this revive between Christmas and New Year is the most statistically visible stock market trend.
It is likely that fund managers are merely rebalancing their portfolios before the end of the year or seeking a bargain before the January effect when stock prices tend to rise. Yet some believe that market psychology is at play. If indices post gains in December, people assume a Santa rally is underway and buy accordingly and this leads to further gains.
As with all trends, it is by no means a definite event. Still investors should take this potential occurrence into consideration when making decisions during this timeframe.
Historically recurring trend
For the past three decades, December has been one of the strongest months for the FTSE Index. In 26 out of 30 years, the index has risen rather than fallen in the last month of the year. From 1985 to 2015, the FTSE made an average gain of 2.26% in December rising in value 83% of the time.
Last year, despite a lot of speculation 2016 would be a gap year for the Santa rally the FTSE gained 8.63% on an upward trajectory between December 2nd and January 13th.
Although most stock indices are affected, the Santa rally is usually focused on US indices. In the last five trading days of the year and the first two trading days after New Year, the average cumulative return in the US over these days is 1.4%. Since 1969 the Santa Claus rally has yielded positive returns in 34 of the past 45 US holiday seasons.
What type of stocks rally in December?
There has been debate recently about when the Santa rally really starts with some analysts claiming it now lasts the whole of December, or even as early as Black Friday as markets gain on strong holiday sales.
Nasdaq reported recently that consumers stepping up their online purchases triggered the Santa rally this holiday season. It said that over 174 million Americans shopped during the Thanksgiving weekend, surpassing the estimated 164 million, according to the National Retail Federation.
Cyber Monday also registered the largest online shopping day in US history. Online sales crossed the $6.6bn mark by the end of the day, reflecting a rise of 16.8% from the same period last year.
Yet, according to the Stock Market Almanac, general retailers in the UK have tended to be weak in December along with banks and fixed line telecommunications. FTSE 350 sectors that are strong in the last month of the year are electronic and electrical equipment, construction and materials, and media. It also said that while December has been a good month for capital gains, it’s the worst month for income investors with only five FTSE 100 companies paying interim or final dividend payments in the month.
Should you invest in the Santa rally?
Analysts are united in stating this would be a bad idea and recommend investing over a longer period rather than taking advantage of short-term trends.
According to Adrian Lowcock, head of investing at Axa Wealth, investors should look beyond the Santa rally as stock markets can deliver better returns the longer you are invested. He added: If you invested only during each December since 1984 your investment would have grown by 72%, while if you had stayed invested all the time you would have seen a 436% return.”
Also there is no guarantee that the rally will even take place.
Will the rally happen this year?
A number of commentators have said that this year's Santa Claus rally is dependent on the eventual outcome of the US tax bill. Republicans in the US Congress reached a deal on final tax legislation recently. If approved in final votes, the package will be sent to President Donald Trump to sign into law before Christmas.
Talk of an imminent 10% market correction could also have an impact. According to Byron Wien, vice chairman of the Private Wealth Solutions Group at The Blackstone Group, this 10% market correction is due soon. He added: "The market is overbought and investors are optimistic. An overbought market with optimistic investors is vulnerable, and the question is what triggers the vulnerability?"
He believes it would be a geopolitical event, such as heightening tensions with North Korea or Russia, or a crisis in the Middle East that creates a spike in the price of oil. Another possibility, he said, is that "the market just begins to fade."
So what happens if the rally doesn’t happen? PNC Financial Services' chief investment strategist William Stone said it was interesting to note that since the early 90's there have been several years when the Santa Claus rally has not been realised, including 1990, 1999, 2004, 2007, and 2014.
He added: "When the rally is not realised, the New Year is dominated by the bears. For example, the January following the 4% decline in 1999 began a 33-month decline in the S&P 500. Also, the decline in the S&P 500 at the end of 2007 kicked off the second-worst bear market in modern history."
The Santa Claus rally goes hand-in-hand with the January effect when stock prices have traditionally climbed. And investors have long looked to January to tell them where the market might be headed for the rest of the year.
Many now believe that the January effect is not as effective as it once was. Jeff Rubin, the director of research at investment firm Birinyi Associates, believes it has waned because the January trade became too predictable. “In order to capture the month’s gains, more investors have been buying stocks in December, leaving fewer left to buy in January.”
The fact that stock markets in the UK, USA and Europe have seen record highs this year is a strong indicator that a Santa Claus rally is on the cards. Yet a market correction or the Trump tax bill could easily upset the apple cart before we get there. Equity overpricing stemming from central bank quantitative easing could also play a role.
It seems that the only thing certain about a Santa Claus rally is that you can only know for sure if it has taken place once it is already over.