As of the end of November 19′, the S&P500 is up over than 25% for the year, while the Australian stock market is following closely behind with a 23% rise since the start of the year. As we approach the end of 2019, investors are increasingly anticipating the markets to finish up at record highs with the help of a trusted ally – the December stock market rally, otherwise known as the Santa Claus Rally.
Historically, December has been the best month of the year for stock markets across several countries, with the global market index up 2.1% on average and having the lowest volatility relative to other months. It also has the highest frequency of advances, with the stock markets having positive returns 79% of the time over the last three decades. Several proposed culprits behind this seasonal effect have been studied over the years.
Holiday Season Sentiment
The most widely accepted reason behind the Santa Rally effect is the psychological effect of the biggest holiday season of the year. Investors are in a more optimistic mood as a result of the holidays, favouring the psychology of buying (stocks) instead of selling. Investors that are likely to receive bonuses at the end of the year would amplify this effect. The large spike in sales during the Christmas season also helps boost the economy through increased consumer spending, further propelling the markets forward.
The January effect is also a seasonal increase in stock prices during the month of January. Historically, January has also been a strong month for stock markets, with global markets in the positive 62% of the time in the last nine decades. A large portion of investors seeks to take advantage of this market anomaly, as they price in their optimism due to this effect, causing markets to rally in December.
In the US, investors have to account for tax considerations in the month of December. Typically, they will buy back into the share market after tax-loss related selling in the third quarter of the calendar year. US investors also usually hold off selling their winning positions in December and postpone their sale to January so that capital gains (tax) will not be realised in the current fiscal year, therefore reducing sell-side pressure in the stock market.
Change in Composition of Market Participants
At the end of the year, institutional traders and fund managers commonly take their holidays and refrain from active trading, reducing the late-year trading volume and hence fewer short trades that are placed in the markets. On the other hand, retail investors with a more bullish outlook will potentially dominate the market composition. With the trading volume likely to lighten and markets filled with bullish investors, equity markets have a tendency to continue its current (upward) trend. The past 7 of 8 times when the S&P 500 index has been up more than 20% through November, December gains have been positive. When the stock market does well in the first 11 months, there is a propensity for it to continue its sprint into the end of the year.
The material impact of these factors could possibly be the catalysts for this market phenomenon in December (individually or collectively), or that the Santa Rally may have became a self-fulfilling prophecy with the growth purely fueled by these expectations. As a supporter of the Efficient Market Hypothesis (EMH) myself, the Santa Rally is likely due to an uncommon statistical occurrence, rather than a market anomaly that can be taken advantage of. Investors should be wary of the dangers of blindly following seasonal effects and realise that past performance should not be viewed as a full proof guide to future market performance.