The Santa Claus rally is not a race between large men with white beards, dressed in red. It is the fairly consistent phenomenon of a rally in the stock market in the first trading days after the Christmas break. But why is this?
It’s not just about Christmas. The Santa Claus rally can continue into the first two trading days in January. This may be because investors are anticipating some kind of rally in stocks during the first month of the year. However, there are also more prosaic reasons.
Firstly, the volume of share trading and the general liquidity in the stock market goes down in the run up to Christmas. Many professional investors, like funds, may also be selling shares because of year end considerations. There is also nervousness on the part of some investors who are going to be away from the market for a couple of weeks over the holiday season. They will be concerned that something might happen while they are on vacation, and it may seem more prudent to take some risk off the table beforehand.
There are usually some trading days between Christmas and New Year. This is often when a Santa Claus rally will occur. With fewer traders in the market, any buying activity will have a disproportionate effect to a normal trading week. But why buy immediately after Christmas?
Some theories include the possibility that portfolio managers are carrying out buying and selling in order to lock in tax savings. There is also the possibility that bonuses are being invested back into stock, pushing some shares up, and there is also scope for more optimism after all those mince pies. But there is no scientifically proven basis for the Santa Claus rally, and the fact remains that it does not happen every year.
A Santa Claus rally is not a done deal
There are years when it does not happen. Natural disasters and political tensions can often dampen the enthusiasm of even the most ardent post-Yuletide bull. Take for example 2004, when the Boxing Day tsunami in Asia made for a very different sentiment in the market. And in 1999 fears about the impact of the so-called Millennium Bug also kept many investors on the sidelines. So for the canny investor, it is worth taking the pulse of the international news environment around 26 December just in case a crisis of some kind is brewing.
However, just taking the average performance of the Dow Jones Industrial Average since 1896 during the last five trading days in December and the first two in January, investors have seen an average gain of 1.7%. Just buying the index has yielded these returns, some stocks will see even bigger gains.
