Is a Santa Claus rally on its way?

What is the Santa Claus rally?

The Santa Claus rally is a historically strong period for stocks at the end of the year. This typically happens in the last five trading days of the year and the first two of the new year.

The term was coined in 1972 by Yale Hirsh in the Stock Trader’s Almanac. He observed that the S&P 500 gained an average of 1.5% during the seven-day period from 1950-1971. Over the years, we have seen this pattern continue. Since 1945, the market has gained during those days over 75% of the time.

Zooming in on the past five years, the S&P 500, Dow and Nasdaq Composite all recorded gains in the Santa Claus rally period, except for the Nasdaq Composite in the last three years and the S&P 500 in 2023/24.

Hirsh sees the Christmas rally not only as a frequent occurrence but also as an indicator of the performance of the market in the coming year. He famously said, “If Santa Claus should fail to call, bears may come to Broad and Wall”, referring to the location of the New York Stock Exchange on Wall Street. What he means is that in years where there is not a Santa Claus rally, it’s more likely that the following year will not be positive for the market and vice versa.

In some years, like 2008 and 2018, the Santa Claus rallies successfully predicted bull markets for the coming year. However, in other years, 2021 for example, this wasn’t the case. There is no clear evidence of a relationship between Santa Claus rallies and market performance beyond coincidence when the two align.

What causes a Santa Claus rally?

There is not a single cause for the Santa Claus rally, but these are some theories behind it:

• Investors often buy stocks ahead of an anticipated rally in January, known as the January effect.
• The holiday spirit fuels optimism during this time of year.
• End-of-year bonuses or gifted holiday money give people money to invest in the market.
• During this time, institutional investors are on vacation, giving more influence to retail investors, who tend to be more bullish.
• The tax year ends December 31^st, so some people may rush to complete trades beforehand.

What is the January Barometer?

On top of a Santa Claus rally, some investors look at the January Barometer to make predictions about market performance trends for the rest of the year. As the name suggests, it analyses stock market performance – specifically the S&P 500 Index – during the month of January.

This barometer works on a simple principle: "As January goes, so goes the year". This means that if the stock market experiences positive returns in January, it is expected to continue performing well for the rest of the year. Conversely, if there are negative returns in January, it could indicate a challenging year ahead.

While the January Barometer has gained popularity among investors and analysts, it's important to understand its limitations. Correlation does not imply causation. External factors such as geopolitical events or economic indicators can influence market trends independently of this barometer.

Trading the Santa Claus rally

Here are some tips you may want to consider when trading during the Christmas rally:

• Do your research: It's important to identify sectors or stocks that historically perform well during this period. Consider looking for companies with strong fundamentals and positive growth prospects.
• Create a watchlist: Compiling a list of potential stocks that you want to monitor closely during the rally may help you. Keep an eye on their price movements and any relevant news or events that could impact their performance.
• Set clear entry and exit points: Consider defining your profit target and stop-loss levels before entering a trade. This will help you stay disciplined and avoid making impulsive decisions based on short-term market fluctuations.
• Diversify your portfolio: Spreading your investments across different sectors or asset classes can help you to reduce the risk. Diversification can also help protect your portfolio in case the Santa Claus Rally doesn’t materialise as expected.

Will we see a Santa Claus rally this year?

As we approach the end of 2024, a Santa Claus rally, according to some strategists, can be real. December is recognised as the strongest month for the S&P 500, with the index rising 74% of the time and returning an average of 1.32%. In presidential election years, this trend is even stronger, with gains occurring 83% of the time and an average return of 1.51%. This year, Wall Street has experienced one of its best presidential election years, with the S&P 500 up over 26%. Despite ongoing geopolitical uncertainties and elevated interest rates, several factors point to a positive outlook for equities as we head into year-end:

• Continued AI investment: Corporate spending on artificial intelligence has surged 500% this year, highlighting robust growth potential, particularly for companies such as NVIDIA, which is expected to post significant earnings growth.
• Election year: Historical patterns suggest that December is typically a favourable month for equities, particularly in presidential election years, with gains occurring 83% of the time since 1950.
• Nasdaq breakout: The Nasdaq 100 ETF is poised to break out of a three-month consolidation phase, signalling potential upside momentum.
• Year-end window dressing: As the year comes to a close, institutional investors typically look to add ‘winning stocks’ to their portfolios, potentially driving up prices for notable names.

Let’s see if Santa Claus is coming to town this year!