End of Year Rally or Fizzle, by D.R. Barton, Jr.

I believe that everyone’s holiday experiences are quite different and very personal. The cliché of the dysfunctional family gathering for Thanksgiving and/or Christmas is so pervasive that it serves as fodder for Saturday Night Live skits almost every year.

My nuclear family is almost formulaic in another way — I’ve been married to my lovely and talented wife for 32½ wonderful years and we have two adult children, one of each flavor (one girl, one boy). The classic 1960’s sitcom nuclear family!

Like many families, we enjoy holiday traditions that we repeat year after year. One of our newer traditions is that we take an overnight trip to New York city a few days before Christmas to enjoy the decorations, see some stand-up comedy, and have a great meal together. This year we had a blast in the mild weather. We got to go late in the season when many traditional out of town tourists had already left, so we got to enjoy the city with less “hustle and bustle” to wade through than usual!

While your traditions may be different, as Christians, we enjoy a Christmas Eve service at church and then head home for our favorite obscure holiday movie. And we each open one package on Christmas Eve.

This year was different, though — for the first time in 25 years, one of our children, now a thriving adult, spent Christmas morning away. It’s a bittersweet thought — I’m happy to see my child growing up and gaining independence to spend time with their significant other’s family. But it’s a different experience for our small family.

And the same might be said for the Santa Clause Rally — we may get a different experience this year. The historically positive Santa Clause Indicator started on the this year on the shortened Christmas Eve (12/24) trading day which saw a major swoon in all U.S. stock indexes. Through the years, the indicator has given rise to a Wall Street aphorism:

“If Santa Claus should fail to call,
Bears may come to Broad & Wall”

—Old Wall Street Saying, unattributed

Santa Claus Rally Statistics

In their well-known Stock Trader’s Almanac, Hirsch and Hirsch explored why end of year trading has a directional tendency and they proposed the Santa Claus indicator (they also provided the quote above).

The Santa Claus indicator is pretty simple. It looks at market performance over a seven day trading period — the last 5 trading days of the current trading year and the first two trading days of the New Year. What we find are some compelling stats.

Since 1969, this seven day period has returned positive results in 36 out of 49 years for a 73.5% win rate and an average gain of 1.3%. Looking back another 20 years shows that the seasonal move holds up with a similar percentage of wins and gains.

Santa Claus Rally Fundamentals

As with any seasonal tendency, I take a look for the fundamentals behind the data. In this case, we have two supporting cases for the short term trend — strong investor psychology and a very tangible institutional money reality as well.

On the psychology side — investors and traders are certainly influenced by the mood of the season. Whether you celebrate Christmas or not, it is undeniably the U.S.’s most permeating holiday with a well-promoted theme of joy and good cheer. It is followed up one week later by New Year’s Eve / Day — a near universal celebration in the western world. Spirits are high, and optimism is the dominating mood of both of these holidays.

On the institutional side, there is a well-known phenomenon of last minute trading to make portfolio returns look better with techniques that fall under the broad term of “window dressing.” This can range from fairly benign practices like adding hot stocks to the portfolio (so that it looks like the manager was in them all along) to more controversial practices such as bidding up stocks that are already in the portfolio. Here’s some interesting research on the subject reported by Jason Zweig:

“A Wall Street Journal analysis of daily trading in roughly 10,000 stocks since 2004 found that on the final trading day of each quarter, there was a sharp increase in the number of stocks that beat the market by at least five percentage points, then trailed it by three points or more the next trading day.”

While that particular practice takes place mostly in thinly traded stocks, the general yearning for stronger results at the end of the quarter and especially at the end of the year certainly adds to the consistency of the Santa Claus Rally.

There is also the simple reality that institutions and funds have new money coming into them during the first couple of days of the quarter and of the New Year. Money from automatically funded accounts (pensions) and other systematic contributions has to be put to work. This well-known money flow effect causes the first two days of the month and quarter to be better performers on average than any other two day period.

So putting the fundamentals and the statistics together, the Santa Claus Rally does seem to have validity and should be taken into consideration as an input (but not the only input!) for your investing and trading decisions.

The past few years have given us some strong outside influences during this period from fiscal cliffs to poor China growth numbers. Seasonal tendencies — even ones with strong histories — are not immune to significant global news. This year’s White House stability uncertainty, tariff troubles and slowing global growth could stall out the Santa Clause Rally, but early Wednesday morning trading shows that a relief rally could put another positive tick in the win column for this Christmas tradition…

Whatever your spiritual tradition, I hope that all the hope, love and joy of this season are with you and your families! And may you have a happy and prosperous New Year!

Your thoughts and comments are always welcome — please send them to drbarton “at” vantharp.com

Great Trading,
D. R.