foxex: The Santa Claus Rally

Chart Advisor | Focus on the Price

By Gordon Scott, CMT

Thursday, December 26, 2019

1. The Santa Claus rally defined

2. Historic Santa Claus rally performance

3. A special case of the turn-of-month effect?

The Santa Claus Rally Defined

In 1972, Yale Hirsch, a stock market analyst and author of the annually published book titled, "Stock Trader's Almanac," identified and named an apparent stock market anomaly. He called it the Santa Claus Rally because it usually occurred during a six-session stretch beginning with the first trading session after Christmas day and ending with the first two days of the next year.

The stock market's performance during these six-day periods includes the last few trading days of the year which share a similar characteristic with Black Friday, and Christmas Eve. While those days typically operate on an abbreviated session schedule and the Santa Claus rally does not, it is also true that such days have notably low volume. In fact the final week of the year typically trades on the lowest volume of any throughout the previous year. With vacations and holiday activity, the only people who trade on these days must really have a need to do so. Those two facts alone make it worth consideration for a period of time that would have unique characteristics compared to the rest of the year.

The chart below shows an example of the timing of the Santa Claus rally. This example takes place from the end of the year in 2008 to the beginning of 2009, and was a rally with the best historic returns.

Historic Santa Claus Rally Performance

While some have disputed that the Santa Claus rally is as much a myth as its jolly-old namesake, the data speaks for itself. Hirsch tracked the rally all the way back to 1896 using the Dow Jones Industrial Average (DJX). However anyone can download and check more readily available data. Simply reviewing the closing price data of State Street's S&P 500 Index fund (SPY) will allow the observer to calculate the return of holding from the close before that six-day stretch to the final close of those days. Doing so shows some very interesting returns.

Not all years produce a winner. The chart below shows the worst performing turn of the year in the last three decades, that of 2007-2008. However the Santa Claus rally does produce a gain more often than a loss. In fact since the inception of SPY in 1993, the Santa Claus rally has produced a gain 17 out of 26 times (about 65 percent of the time).

Read more:

Six Things To Buy AFTER Christmas

How to Pay off Christmas Debt

What People Spend on Christmas Around the World

A Special Case of the Turn-Of-Month Effect?

Over the years many analysts have tried to speculate about the reasons for the Santa Claus rally and why it should persist for over a century, and even show up so strongly in more modern, ETF-driven markets. One possible explanation may be found in a few academic studies which have documented the turn-of-month effect. This is the concept that stocks tend to rise after the end of the month and perform well in the first days of a new calendar month. There is ample data to suggest this is a persistent phenomenon.

If we consider that the Santa Claus rally is a year-end version of this effect, it may be the case that the more determined crowd making trades during that period of time tends to generate more positive returns. Whatever the actual reason, a comparison of the returns from trading the rally on SPY over the past 26 years shows a pretty dramatic story.

The chart below compares the results of trading any random six-day period in the last 26 years, with the results of trading two kinds of six-day groupings. The first is the turn of month effect, four sessions at the end of a month and two sessions into the next month. The second is specifically the returns from trading the Santa Claus rally.

The Bottom Line

Trading any random six-day stretch on SPY over the past 26 years produces a positive return 58 percent of the time. But trading the four days at the end of the month and two days in the next actually produces winners 64 percent of the time. The Santa Claus rally bests both of these with 65 percent winners and produces demonstrably better returns shown in the chart above.