How does Christmas affect the stock market?

Stock markets can be notoriously volatile – but there are certain times of the year when investors expect them to behave in certain ways. These are known as the seasonal rallies and have been identified by analysts that have spent hours trawling through decades of data to spot trends. But are they actually true?

In this piece we try to separate the fact from the fiction by looking at what’s expected to happen during these periods and how they can affect your investments.

What is the Santa Claus rally?

Let’s start off with many people’s favourite time of the year: Christmas. The Santa Claus rally is often quoted in early December as everyone’s attention starts turning towards the festive period. The concept is that the market will enjoy an uptick in returns during the last trading week of December and the first two days of the new year.

The phrase was first coined half a century ago by Yale Hirsch, the creator of the first Stock Trader’s Almanac, which was published to share views on trades and investments. According to Hirsch’s son, Jeff, who has taken over as the Almanac’s editor, the rally – or lack of it – is the first indicator of market sentiment for the coming 12 months. “Years when the Santa Claus Rally has failed to materialise are often flat or down,” he has said.

But is there any truth to the theory? Well, an analysis by investment house Schroders found US stocks recorded a positive return in 77.9% of Decembers between 1926 and 2020*.

While that’s not a 100% record, it’s not bad. According to the research, which used Morningstar Direct data, stock prices returned an average of 1.6% during the final month of the year*.

Reasons for the Santa Rally include the general wave of positivity ahead of the holiday season, as well as fund managers carrying out year-end rebalancing of their portfolios. Whatever the reason, such a rally is a welcome end-of-year boost for investors – especially if the previous 11 months have been on the challenging side!

What is the January effect?

The Santa Claus rally gives way to the so-called January effect. The argument here is that the first month of the year is usually good for investing. This theory that stocks tend to enjoy greater gains in January than other months is credited to investment banker Sidney Wachtel and dates back 80 years to 1942.

But, what’s the truth? Is January often a boom time? According to research by Schroders, there is definitely some evidence backing up Wachtel’s original findings all those years ago.

Its data, which was compiled up to December 2019, found that in 85 of the past 130 years, the US stock market has actually risen during the first month of the new year**.

In fact, the figures achieved are even higher in some other markets. January has been a positive month 71% of the time in the UK, 74% in Japan and 78% in Australia, it found**.

Of course, there may be logical explanations for the effect. For example, some investors in the US in particular may sell losing positions for tax reasons in November and December before buying them back in January after the prices have sunk on lower demand. Other observers have suggested corporate bonuses being invested at the start of the year is the reason for the increased performance.

Should you sell in May and go away?

The third main seasonal rally on our list is called ‘Sell in May’. The concept here is that returns generated between November and April are stronger than they are for the second half of the year. Those in favour of this idea will argue that they can sell stocks at the beginning of May each year and then buy all the positions back at the end of October.

But does it work? Is there anything backing up the theory? Well, according to research conducted by Barclays, there could be some truth in the idea that the colder months of the year are more conducive for markets. Researchers analysed monthly returns across 19 share markets and compared the figures generated by the two respective half-year periods, between 1970 and 2017***.

“We discovered that the monthly returns were, on average, 1-2% higher in winter than in the summer period,” it stated. “This indicated that investors would have earned, on average, 6-12% more through the whole winter period than the summer.”

However, even if the theory holds water, the concept of selling assets in May is not advisable as markets still tend to rise during the summer, albeit at a lower rate.

Conclusion

Of course, it’s worth remembering that you can read virtually anything into a set of numbers and there are certainly no guarantees when it comes to investing. While there appears to be clear evidence that seasonal rallies have happened in the past, you need to acknowledge the years when they’ve been absent. The best advice is to stick to your investment goals and objectives, rather than becoming too fixated and distracted by such theories.

*Source: Schroders: Is the Santa Rally real? 23 November 2021
**Source: Schroders: Does the January effect exist? 7 February 2020
***Source: Barclays: Should you sell in May? 7 July 2021

_{Photo by Absar Pathan on Unsplash}