Trying to predict the short-term market is about as effective as analyzing a lottery ticket. That said, the market has been known to follow certain seasonal trends at different times of the year.
We recently wrote a blog explaining why September was traditionally one of the most volatile months in the stock market. The market has an unsettling habit of taking an early Autumn stumble every year – with the Dow Jones, the S&P 500, and NASDAQ falling 1.1%, 0.7% and 1% on average respectively every September.
The uncertainty surrounding the annual ‘September Sell-Off’ stems from various sources, including the ending of fiscal years and the speculative influence of the media.
The market tends to rebound fairly quickly though. For instance, last year the Dow Jones dropped to a low of 18,035 in the second week of September. Given that there was a particularly erratic election campaign going on at the time (to put it mildly), the markets remained unsettled well into October.
But once the election had passed, there was a strong rally. The point is that the markets are subject to seasonal shifts and changes. And as we hit the end of the calendar year, we encounter a new set of short-term seasonal movements.
Although these minor movements shouldn’t affect long-term investors in the grand scheme of things, it can be interesting to be aware of and understand these trends in order to anticipate movements in the future.
The ‘Santa Claus Rally’
While most of the Western world works itself into a holiday frenzy come December, the markets have typically had their own little end-of-year bump too.
The term ‘Santa Claus Rally’ was first coined in the Stock Trader’s Almanac by Yale Hirsh back in 1972. He wasn’t referring to some sort of Polar-themed track-day, however, but rather the boost in the market that was experienced in the last trading days of the year between Christmas and New Year.
In more recent times, the term has been stretched to encompass almost all activity from Thanksgiving to New Year’s Day.
While the jury might be out amongst modern experts and analysts as to the true existence of a ‘Santa Claus Rally’ (much like the man himself), the market does tend to spike in the period between Christmas and New Years more often than not.
And there are a few things that are believed to cause this:
One of the most cited reasons for an upswing in the post-Christmas market is the end of year trading of equities for tax purposes.
The US tax year ends on December 31st. In order to use the losses they incurred during the year to counteract the capital gains tax they’re due to pay, some investors and hedge funds will sell off losing stocks before the year is out to buy back in January. If these losses actually occurred earlier in the year, however, the effect of them being sold serves to stabilize the market, or even drive it up.
Some attribute the seasonal market rally to the decreasing amount of day-traders and professional short-sellers operating around the end of the year.
Many companies will start to wind down their trading for the year towards the end of December, which reduces the liquidity of the market. The less liquid the market, the more influence even small upward movements can have on the market as a whole.
Or maybe it’s just the general festive nature of the period that comes into play.
Workers usually receive a holiday bonus in their final paycheck of the year, and if they can resist the urge to blow it all on some last-minute shopping, it might just count for some extra spending in the markets.
Not only that, but the sense of general goodwill and positivity, not to mention the subliminal feelgood messages of modern advertising, can provide that little push some investors need.
Our new national holidays—Black Friday and Cyber Monday—also have an interesting part to play. The concentration of a massive amount of retail sales into such a short period of time can make or break the quarter for a lot of publicly-traded companies. And as the figures begin to emerge of how well (or how poorly) they performed, people are encouraged to buy shares in the hope of a great earnings call come January.
The January Effect
Speaking of January, some experts consider the Santa Claus Rally to be a result of people buying stocks in anticipation of the rise in stock prices at the start of the next year, otherwise known as the January Effect.
Although it’s not believed to have as much influence in a more efficient modern market, there was once a regular and significant boost every January in the market price of small-cap stocks that had been unloaded the previous December.
A history of rising stock prices every January was never going to go unnoticed by traders, so keen to get ahead of the pack, many people started buying stocks in the final days of December in the hope of seeing their investments rocket come January.
Finally—and perhaps most logically—is the belief that the ‘Santa Claus Rally’ and most other seasonal trends in the market are nothing more than self-fulfilling prophesies.
Like many phenomena in the market or the world in general, basic human psychology shows that we try to find recurring patterns in almost everything we do.
So if trader and investors are expecting the market to rally towards the end of the year, any sign of growth will prompt more buying, which will, in turn, stimulate growth, which… well… you get the drift.
So there you have it! There are a variety of reasons why the market usually takes a jump around the end of every year.
As long-term investors, these small fluctuations shouldn’t bother us too much. But understanding market trends and how they change is important in becoming a well-rounded investor.