The Santa Claus Rally
In the final weeks of the year, security prices often experience a surge, known as the Santa Claus rally. The Santa Claus rally refers to a tendency for stock markets to exhibit a positive trend in the final weeks of December, typically between Christmas and New Year’s Day. Whilst this is not a certainty, it is a noticeable pattern that has appeared many times during varying market conditions.
Drivers Behind the Rally
There are several potential drivers behind the Santa Claus rally, including quarterly portfolio adjustments, tax planning, lower trading volumes, and improved sentiment. Institutional fund managers tend to make adjustments to their portfolios at the end of each quarter in a rebalancing effort to realign their investments with their desired asset allocation, with Q4’s adjustment falling over Christmas and the run up to New Year. This huge buying volume from institutional money managers can often contribute to a boost across equity markets.
As well as portfolio rebalancing, investors engage in tax planning strategies towards the end of the year. Standard practice is tax-loss harvesting, which is a strategy designed to reduce the current year’s tax bill. It works by selling investments at a loss and using those losses to offset the capital gains from investments sold at a profit. This selling pressure in December can often cause a mild pull back in valuations, setting the stage for a rebound into yearend as investors look to reinvest, providing support to equity prices.
In the final two weeks of the year, how and when people work tend to change, with institutional investors and fund managers spending more time away from the office to celebrate Christmas and New Year. This reduction in large market participants typically results in lower trading volumes. With reduced liquidity due to fewer active market players, even smaller trades can have a more pronounced impact on stock prices. This low-volume environment can sometimes exaggerate market movements, leading to an upward push in prices as buyers outnumber sellers.
Seasonal optimism and a general improvement in consumer sentiment can also provide support for stocks over December. The festive season often ushers in a sense of positivity, encouraging spending as consumers shop more, dine out, and engage in leisure activities, boosting earnings potential across several industry groups. This is often anticipated by investors, increasing the perceived value of certain companies contributing to share price growth.
General economic factors and policy decisions always have the potential to contribute to stocks market gains over the period, as they do during any other time of the year. In the current environment, where inflation is falling, particularly in the US, investor sentiment is improving in anticipation of the Federal Reserve unwinding higher interest rates next year. This provides a tailwind for prices, especially for growth stocks, which achieve a higher valuation when future cashflows are discounted at a lower rate.
Likelihood of a Rally This Year
Predicting market movements is inherently challenging, and the Santa Claus rally is no exception. While historical trends may provide guidance, they do not guarantee future outcomes.
Over the last 20 years, there has been an average return of 0.385% in the week leading up to the 24th of December. In that period there have been 13 positive weeks, with five negative weeks and two unchanged.
2023 has seen volatility remain largely present in the markets, with a variety of factors such as inflation and monetary policy, mixed corporate earnings, and geopolitical unrest all influencing market movements. In assessing these factors, investors may ponder whether there is a possibility of a Santa Claus rally to close the year out, and how best to gain exposure to it.
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