Google “Santa Claus Rally” and you will find a confusing mix of articles written about this seasonal tendency. Even the online investment dictionaries have varying definitions. Many journalist combine and confuse other seasonal effects with the Santa Claus Rally to include the January effect, the December effect, the Holiday effects, and the January Barometer. Something had to be done. I did some research on its history, but more importantly I took a hard look at the numbers to answer the question is the Santa Claus Rally or the Turn-of-Year (TOY) effects tradable. The bottom-line is it can be, but with caveats. Here is a excerpt from The Santa Claus Rally Guide posted on the TSP & Vanguard Smart Investor website:
The Turn-of-the Year Seasonal Effects
The Santa Claus Rally has become synonymous with an expected end-of-year rally in the stock market, but it has varying definitions leading to confusion among the media and investors. While I hope to clear up some of the confusion, our main focus should be on the actual market action to see if a seasonal effect truly exists and more importantly is it tradable. The explanations for the stock market seasonal tendencies are many and we will touch on them, but consistent tradable tendencies are what we are looking for. Since varying definitions exist, we need to frame the discussion.
I prefer to use “Turn-of-Year” (TOY) to describe the seasonal effects that exist at the end of the year and the beginning of the New Year. It is also an umbrella term to frame the varying effects mentioned by the media and other analyst to include the Santa Claus Rally, the December effect, the January Effect, the Holiday effects (Thanksgiving, Christmas, New Year’s), the Turn-of-Month effects and Tax Payment effects and others. Each effect has its own explanation for what drives it and some effects are over-lapping in time, but we found the culmination of all of these effects create distinguishable results on the stock indexes which can be useful to investors.
Key factors in analyzing the “The Santa Claus Rally” are the time frames examined and the indexes used. Our Almanacs and data show the SP500 has seasonal tendencies but they are less than the Dow Jones Industrial Index which again is less than the small capitalized stocks such as the Russell 2000 index. While seasonal tendencies have been studied for over one hundred years, the drivers of these tendencies have changed with changing tax laws and the investing community. Looking back beyond 1950 provides good academic reading, but is less important for today’s investors than the last 60 years and last 25 years. And of course too short a period does not provide enough data points.
Depending on the analyst or definition, the Santa Claus Rally starts after Thanksgiving, the beginning of December, the last half of December or the last five days of December or after Christmas and of course ends of varying dates. The January Barometer is either the first 5 days or entire month of January. WikiInvest, Wikimedia, and Investopedia all use slightly different definitions adding to the confusion. Let’s take a look at their definitions:
Investopedia: A surge in the price of stocks that often occurs in the week between Christmas and New Year’s Day.
Wikipedia: A Santa Claus rally is a rise in stock prices in the month of December, generally seen over the final week of trading prior to the New Year.
WikiInvest: The time period associated with the Santa Claus Rally is the last five trading days of December and the first two trading days of January.
First let’s look at some of the history and try to clear up some of the confusion. Then we will frame our own analysis for proper comparisons.
The Santa Claus Rally
In 1942, S.B. Wachtel presented in the The Journal of Business of the University of Chicagoevidence from 1927 to 1942 of a December-to-January seasonal rise in the Dow Jones Industrial Average (DJIA) and he listed possible causes as tax-selling depressing prices in December followed by a rise into January, a liquidity preference before Christmas, a general good-feeling around the holidays among others. Other academic studies were to follow but the term Santa Claus Rallywas made popular around 1972 in a Stock Trader’s Almanac (The Almanac Investor).
The Almanac Investorrefers to the Santa Claus Rallyas the last five trading days of December and first two trading days of January. The Santa Rally–like the January Barometer–is considered more of an “Early Warning System” for the coming year than a speculative trade. Their theory is simply that if one of the best and most consistent stock market trends fails; watch out for the rest of the year.
Since monthly returns are easier to find and analyze, many journalists take the easy route and only compare full month returns. But a proper analysis requires a closer look at the daily price progression through this time frame. We agree that tax loss selling is part of the effect, so it makes sense that investors are going to do the majority of their selling prior to starting the Christmas holiday thus depressing prices of some stocks that impact the indexes during the month of December. But once the selling pressure lets up, buying will begin.
ATurn-of-Month effect exists in the indexes for many, but not all months due to the end-of month payment of payrolls that also include deposits in retirement accounts. In turn, these funds are invested in the major stock indexes. We can see this slight bump around the end and beginning of most months and to a lesser degree the middle of the month. But now consider that many employers delay matching contributions in retirement accounts and bonuses until the end of the year increasing the flow of funds into the indexes. How and when these funds flow into the market partially determines the seasonal effects of each specific index.
We will look at the following TOY time frames:
1. Thanksgiving and the end of November.
2. December: Closing prices on the last day of November through the last day of December
3. January: Closing prices on the last day of December through the last day of January
4. Santa Claus Rally: Last 5 trading days of December and first 2 trading days of January
5. Best Dates: The best dates to enter in December and best day to exit in January based on the TSP & Vanguard Smart Investor’s almanacs.
Our study focuses on the SP500 index and the Russell 2000 index. We calculated two unique numbers in addition to the cumulative returns. First is the percent of the annual return captured in these short time frames. Second, the ratio of the average daily returns within the examined timeframe divided by the average daily return of the SP 500 index for the full year. A ratio of “3.0” means the average daily return during the period is 3 times the average daily return of the SP500 index the entire year. We also present the Win-Loss Data for each trade. We have seen journalist state the seasonal effects appear to be diminishing after presenting the raw numbers. But remember since 2000 the market as a whole has significantly under-performed the bull market preceding it. The percent of annual returns and the daily ratios allow us to see the relative numbers.
Continue with our free The Santa Claus Rally Guide to see the data on the rally.
Categories: Seasonal Analysis