Australia | Dec 07 2023
There’s just one thing investors want for Christmas.
By Daniel Goulding
As the holiday season draws near, financial and social media platforms will be lit with talk of the Santa Claus Rally. This catch cry will be bandied about as pundits debate the likelihood of a year-end surge in stock prices. However, it's important to note that not all year-end gains qualify as a Santa Claus Rally, and it's primarily a seasonal indicator rather than a trading strategy.
The phrase was coined by Yale Hirsch1, the original editor and publisher of The Stock Trader's Almanac in 1972. He used it to describe the tendency of stocks to rise during the last five trading days of December and the first two trading days of January.
Hirsch noticed if the market rallied during this period, it was often followed by above-average market performance over the next 12 months. Conversely, a market decline pointed to the likelihood of much lower prices, even an outright bear market.
As Hirsch put it, "If Santa Claus should fail to call, bears may come to Broad and Wall."2
Since this indicator was developed in an American setting, let's take a look at the empirical data to see how it has fared in Australia.
Exhibit 1 illustrates the returns of the Santa Claus Rally for the Australian benchmark share market index since 19803. It has risen 79% of the time for an average gain of 1.81%, which is consistent with empirical data from other countries.4
Exhibit 2 reveals those years when Santa failed to show. It does appear that investors are often “gifted” a much better buying opportunity throughout the subsequent 12 months.
Exhibit 3 compares the instances where Santa rewards investors, and when he does not. Investors have been gifted with an above-average return when Santa comes to town. When Santa fails to show, it points to the likelihood of a below-average market return.
Why does the Santa Claus Rally exist?
The Santa Claus Rally is considered a calendar effect or calendar anomaly, which is an empirical result inconsistent with the conventional model of the financial universe – the Efficient Market Hypothesis (EMH).
The EMH is one of the most important, yet controversial concepts in the world of finance. If markets are truly efficient per the EMH, one should not be able to use seasonality to estimate future returns. A review of the literature suggests that calendar effects are more than just statistical aberrations.5
Several explanations have been offered for the Santa Claus Rally's existence, including a lull in institutional activity as traders go on holidays, window dressing6, tax loss selling in the US, holiday cheer, new-year optimism, and investors jostling early for the January Effect7.
I view the “Santa Claus Rally” indicator primarily through the lens of Behavioural Finance. Humans are not machines, cold and calculating, but rather emotional creatures.
Seasonal influences do not change how we think but can influence how we feel, and feelings can catalyse trading behaviour. If the market fails to move higher during the season to be jolly, there is potentially something amiss in markets. And in a game of inches, every edge helps.
While past performance is no guarantee of future results, neither is it irrelevant in the real world.
1. Jae Kaeppel writes “It might be appropriate to refer to Yale Hirsch as the “founding father” of seasonal trend analysis in the stock market”. Jay Kaeppel, Seasonal Stock Market Trends, (Hoboken, New Jersey: Wiley, 2009), 7.
2. Jeffrey A. Hirsch, The Little Book of Stock Market Cycles, (Hoboken, New Jersey :2012), 136
3. Defined here as the S&P/ASX All Ordinaries from 1980 through 1992, and the S&P/ASX 200 from 1993 onwards.
4. Srinivas Nippani, Kenneth Washer, & Robert Johnson, Yes Virginia, There Is a Santa Claus Rally: Statistical Evidence Supports Higher Returns Globally, Journal of Financial Planning 28, no. 3, (2015): 55–60.
5. Nikunj Patel & Martin Sewell, Calendar anomalies: a survey of the literature, International Journal of Behavioural Accounting and Finance, 5, no. 2, (2015): 99-121.
6. Window dressing is a term used to describe superficial changes made to a portfolio ahead of a reporting period, to improve its appearance to investors.
7. The January Effect is the seasonal increase in stock prices throughout the month of January.
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Daniel Goulding is a technical analyst with over 20 years of experience. He is the publisher of The Goulding Market Letter, and previously The Sextant Market Letter. In the past, he worked as an adviser for the Townsville branch of RBS Morgans, and later Grow Your Wealth Financial Services Townsville.
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