As the holiday season approaches, investors and market enthusiasts turn their attention to a well-known phenomenon known as the "Santa Claus rally."
This annual occurrence sees stock markets regularly experience a surge in prices heading into the new year. Seasonality in financial markets refers to the tendency of certain assets or indices to exhibit recurring patterns or trends at specific times of the year. The Santa Claus rally, specifically, refers to the historical trend of stock markets experiencing a positive upswing during December through the beginning of the new year. This period is often characterized by a boost in market sentiment although trading volumes may be lighter.
The two charts below plot the historical tendency for markets to move higher in November and December over the past 30 years, plotted along with the returns for 2023 as a comparison. As you can see, there is a reasonably strong history of higher stock prices, particularly in the United States. Between 1994-2022 the S&P500 averaged a gain of 2.52% for the period, compared with a more modest 1% gain for the ASX200. This compares with gains in 2023 so far of 9.32% and 6.33% respectively.
Several factors are touted as contributing to the existence of the Santa Claus rally. One significant reason is tax considerations: Investors may engage in tax-loss harvesting earlier in December for US investors, selling off underperforming assets to offset capital gains, which can create downward pressure on stock prices. However, 2023 has proven so far to be an exception to this, and typically once tax-selling pressure subsides, investors often return to the market, resulting in a rebound.
Another factor is holiday optimism and sentiment. The holiday season tends to bring about a sense of goodwill and positivity, both in the broader economy and among investors. This festive spirit can lead to increased consumer spending, which benefits certain sectors like retail, potentially driving up stock prices.
Additionally, many institutional investors take time off during the holiday period, leading to reduced trading activity and lower volatility. With fewer market participants, it becomes easier for even small trades to influence prices, potentially leading to a bullish trend.
It’s important to note that while the Santa Claus rally is a historical pattern, it is not guaranteed to occur every year, and market conditions can vary widely. Investors should exercise caution and not rely solely on seasonal trends when making investment decisions.
While historically December has on average been one of the stronger months of the year, 2023 has proven to be a particularly strong year in this regard, with the ASX200 up 6.33% from the beginning of November until today, although there have been prior years which have experienced stronger returns. Time will tell if this trend continues until the year-end, but many investors would already be feeling that Santa has come early for them this year.
Overall, the Santa Claus rally is a notable seasonal phenomenon in financial markets, characterized by a late-year increase in stock prices. While tax considerations, holiday sentiment, and reduced trading activity are contributing factors, it’s crucial for investors to remember that market behaviour can be unpredictable. Staying informed and maintaining a diversified portfolio remains the key to successful investing.
