A few years ago, I was at the office and I heard some of my financial colleagues speaking about a Santa Boom or Bust, or more commonly known as a Santa Claus Rally. I was curious. It seemed odd to me that we would associate a holiday surrounded by lights, presents, and good cheer with the idea that Santa would bring a change in the stock market. So, let’s talk about what’s really at play here.
Each year, when the days are at their shortest and retail workers’ shifts are at their longest, market speculators prognosticate about the likelihood and magnitude of a year-end surge in stock prices. Called a Santa Claus Rally, this phenomenon describes a trend for stocks to go up by a percent or two during a specific period of time. This moment is marked by the seven-day period with five market trading days before the end of the year, and the first two trading days of the new year.
Now, the name of the Santa Claus Rally didn’t really come on the scene until 1972, but it has really existed since the early 1900s. We all tend to believe what we can see, and even more so, we start to understand more about what actually happens a lot of the time. The reality is that this trend has happened 80% of the time in the years dating back to 1900. As the stock market itself can contain factors that are real (P/E ratios, earning reports, dividends, etc.), it can also contain a lot of factors that aren’t proven. We often call this speculative or seemingly possible. The problem with the latter assumption is that this speculation, believed by enough people, can drive a stock price up or down. (Take a look at what happened with the 2021 controversy around Reddit and GameStop. The stock price was driven up on this video game buy/sell/trading company.) What drives this feeling at this particular time of year?
There are several theories:
Post Christmas Spending: The Santa Claus Rally happens after Christmas, so we can’t really call it holiday-related spending, but 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 picking up on year-end sales. (Personally, this is when I buy most of our holiday lights for the next year, generally with significant discounts at Menards and Walmart.)
Tax-Loss Harvesting: At this time of year, our office is usually meeting with clients for a specific reason. Usually, it’s to determine if we are going to do ROTH IRA conversions (stay tuned to our January article to see more information on this, and if it is a good idea for your portfolio). It can also be to rebalance taxable gains in an effort to “lean the scales” toward a more attractive short-term or long-term loss, for write-off or gain for taxable measures. This practice of large-scale selloffs to reduce taxes or intentionally pay them in the current tax year depresses many stocks’ prices and sets the stage for year-end gains. To the stock market, an animal without intuition, this sell-off appears to simulate a running away from stock investments; this thought process may have the Dow Jones drop near the end of the year.
Institutional Investing: One theory is that the short-selling they would normally do doesn’t happen. Short positions are a sign of bearish sentiment, or the idea that the market may go down. Without this sign of trading behavior, we get a brief, self-perpetuating burst of bullish activity, or larger volumes of buying atmosphere. There are a couple of problems with this theory. First, larger investors aren’t necessarily doing a lot of short selling. It’s costly and risky. Second, if the Santa Claus Rally is such a great time to be active in the stock market, it seems unlikely that larger investors would blow it off.
Another theory is that institutional investors, the same ones who are supposedly away from their desks, sipping cocktails 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. Much like many beliefs of the government, “Is the market really that efficient?” This is definitely up for debate.
Influxes of money: Another theory is that year-end bonuses or Christmas bonuses handed out by small and large employers to their employees will be spent or invested. This economic stimulation of new money into the system could have the effect of driving prices up and in turn raising stock prices by a demand curve of performance. The flaw in this theory is that not all bonuses come in this seven-day period. Also, if this was true, wouldn’t the market also price this in as a normal activity? Again, doubt does exist.
Believe it…and it can happen(?): The idea that we can simply “will” something to happen doesn’t happen that often. However, let me reference again the power of many people with the same vision. In 2021, the power of social media drove the market to find unrealistic prices for four days to a company called GameStop. I’m not saying that if you believe it can happen, it won’t; but I do believe that the market, though lacking intuition to human behavior, has the ability to adapt and change. The next time something like this happens, the past mistakes will help to direct this future change.
The Joy of the New Year: The holiday season might have people feeling more optimistic, especially with corporations and governments reluctant to announce bad news during this period, if they can avoid it. Let’s not forget about the January Effect. The January Effect is that generally the start of the new year brings anticipation of a fresh start.
This emotional desire to better oneself, set resolutions, or take advantage of the start of a 12-month climb will often bring investors to the table. 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 being said, plenty of people are miserable during the winter holidays: they’re sick, lonely, exhausted, grieving, or cold. So theoretically, Santa Claus Rally concepts must assume that these people are not checking their portfolios or making trades. Also remember the S&P enjoyed a rally over the 2019 to 2020 Santa period despite the news reports that emerged on December 30 about a troublesome respiratory virus in China.
I often look at these types of situations like I do with a trip to the casino (which with young children at home, we don’t do nearly as often). When we go to the casino, we come with our $20 or $50 with the mindset of, “Let’s see how long this can last us.” After 15 minutes, I usually find myself having already lost my $20, and then it is time for me to walk around with a drink in hand and watch others lose money. Basically, I enjoy watching the game more than losing to the game. So, let’s take that analogy and relate it to the Santa Claus Rally. If you enjoy reading into the hype, you can try trading in the 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.
Merry Christmas to all and blessings for a Happy and Safe New Year’s.