Getting the Santa Claus Rally Right By, D. R. Barton, Jr.

I get a kick out of all the Santa Claus rally references I hear from various writers and reporters. Almost all of them mean “markets rallying, leading up to Christmas”. I’ll call that the Santa Claus rally with a small “r”.

The Santa Claus Rally I want to review with you today is the one with a capital “R”. The Santa Claus Rally was first described by the father and son team, Hirsch and Hirsch, in their long-running Stock Trader’s Almanac. And it’s a quite positive indicator, as we’ll see.

It’s good to get some additional positive items in front of us. Whatever spiritual tradition you follow, the Christmas holidays can be stressful as expectations run high to get things done, either for you or your family’s celebrations or just to get stuff done by the end of the year. Practically everyone has traditions, but as our relationships with families and friends mature over the years, so do these traditions.

I mentioned in my Trading Tip last week that my family is making a trip to see my dad, who turns 88 this weekend. For his birthday, we are taking him to an escape room in the local university town. An escape room is an activity where a team of people are locked in a room and have to decipher clues and solve a series of puzzles and riddles to find the key or combination to the door. This is a new tradition of ours, born out of the necessity to find something that seven adults can enjoy together in the winter. And all three generations of us chip in to help play the live-action game.

When we get home next week, we will enjoy a Christmas Eve service at church where my wife leads the praise band and I’ll tag along to drum for her crew. We’ll then head home for our favorite obscure holiday movie. And we each open one package on Christmas Eve.

Our adult children have significant others with extended families, so we never know from year to year who’ll be home when over the Christmas holiday. But we know we’ll enjoy time with them whenever it occurs. Every year now is a new experience.

And the same might be said for the Santa Claus Rally. We may get a different experience this year. The historically positive Santa Claus Indicator starts on the shortened Christmas Eve (12/24) trading day. However, with Christmas Day and New Year’s Day falling on Saturdays this year, the Santa Claus Rally period will start on Monday (12/27) and last through Tuesday (1/4/22). And in an unusual occurrence, there will be no New Year’s holiday observed at the NYSE for 2022 (…pursuant to NYSE Rule 7.2, NYSE American Rule 7.2E, NYSE Arca Rules 7.2-O and 7.2-E, NYSE Chicago Rule 7.2, and NYSE National Rule 7.2).

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

The Santa Claus indicator is pretty simple. It looks at market performance over a seven-day trading period—the last five 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 39 out of 52 years for a 75% win rate and an average gain of 1.4%. 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 want to know the fundamentals behind the data. In this case, we have two supporting cases for this short-term seasonal—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 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 must 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.

Whatever your spiritual tradition, I pray 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.

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