Is The Santa Claus Rally For Real, And Should You Trade It?

You might hear investment professionals on TV talking this time of year about the “Santa Claus rally” for stocks.

So is St. Nick actually buying stocks? No, but the data around year-end is interesting to consider.

Numbers going back to 1969 suggests that owning stocks in the final five trading days of the year and the first two trading days of the New Year is a good idea — most of the time. In 34 of 45 seasons returns were positive 1.4% in those seven days.

Another study noted that a random six-day period in the S&P 500 Index over the past 26 years produced positive returns 58% of the time. That same string of days at year end produced winners 65% of the time.

Many investors believe that the Santa Claus rally, when it happens (sometimes it doesn’t), is due to retailers reporting positive numbers for the year.

That’s because many stores don’t break even until Black Friday — that’s the “black” part, as opposed to red, or losing money.

But there are likely to be other factors at work.

First of all, professional traders tend to take the last two weeks of the year off. They have little incentive to sell much if the year has been generally good, since they might see even more upside in early January when most pros return to work.

As a result, the upward bias of stock buyers helps at least dampen the risk of a sell-off in the final trading days of the calendar year.

Second, professionals on the sidelines leave retail investors alone on the field. Small investors tend to be even more bullish, and that can trigger buying.

Finally, investors often reorganize their portfolios before Jan. 1 in order to realize tax breaks. They might take profits or get out of losing positions, but the presence of giddy retail buyers often mops up the excess.

Why? Because closely following Christmas break is the month of January, usually a winning month for stocks, known as the “January effect.”

Naturally, you can find bad January performances if you look, but as usual expectation sometimes dictates outcomes, irrespective of facts.

Trade the rally?

Should you try to trade the Santa Claus rally? Almost certainly not, for several reasons.

First, the numbers are reflective of the entire stock market, not individual stocks. The chances you own a given stock that might lose money in any given period of time is high.

Second, to make serious bank on any kind of short-run rally you would have to risk a lot of capital. While a rally can mean positive returns, timing your way in and out of a large position is fraught with unnecessary risk. What if you bet half your portfolio and stocks go down?

The more reasonable course is to rebalance periodically. If the market gives you a run up on stocks, you can take those profits and reinvest them elsewhere when you rebalance, whether that’s quarterly, twice a year or annually.

That way, you don’t have to guess if this is the year Santa hands you coal instead of gains in your portfolio.

MarketRiders, Inc. is a registered investment adviser.  Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.  Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.