The ‘Santa Claus Rally’ refers to a historically observed stock market phenomenon where U.S. equity markets tend to perform well during the last five trading days of the year and the first two trading days of the new year. Historically, the average gain during this seven-day period is around 1.3%.
Seasonality plays a major role in this phenomenon as November and December are typically two of the best months of the year for the markets. It certainly doesn’t hurt that the S&P 500 index gained 5.7% for November and its year-to-date gain is around 26.5%. In addition, the Nasdaq Composite rallied 6.2%, the Dow added 7.5% and the small-cap Russell 2000 tacked on 10.8% in November. Since December 1936, stocks have returned an average of 2.3% in December and generated a positive return 79% of the time.
Past Rallies
The Santa Claus Rally that produced the best returns was at the end of 2008 and beginning of 2009 when a recovery from the financial crisis was getting underway. According to The Stock Trader's Almanac, the S&P 500 rallied 7.4% in the six-day period between 2008 and 2009 – almost double the gains of the next strongest rally.
The second-best rally came ten years later at the end of 2018. These two rallies were derived from similar circumstances, as the 2008 rally came at the end of the worst year for the S&P 500 since the Great Depression, and the 2018 rally came at the end of the worst year for the S&P 500 since 2008.
Context Matters
The question on many traders’ minds is whether Santa visited early this year or if he’s yet to make his guest appearance. Statistically, December equity returns are higher if the year-to-date performance of the market has also been higher going into December. In the last 20 years, when the S&P 500 gained more than 10% through the previous 11 months, the average return in December was 2.2%. Conversely, in those years when the index was up less than 10%, the average monthly return in December was -0.6%. Further, going back to 1950, the month of December is higher 83% of the time during presidential election years.
There are a few general theories behind the Santa Claus Rally which attempt to explain why it occurs:
Optimism and Holiday Cheer: The holiday season may foster a sense of optimism among investors, leading to increased buying activity.
Tax Considerations: Some investors may sell losing positions before year-end to harvest tax losses followed by reinvestments in the market. However, this selling needs to occur before November, usually in October, for the Santa Claus Rally to have a greater chance of occurring. Tax-loss harvesting may be one reason why October tends to be one of the weakest trading months of the year.
Low Trading Volume: With many institutional investors and traders on holiday, retail investors may exert greater influence on the market.
Year-End Bonuses: The influx of year-end bonuses may lead to increased investment activity.
Portfolio Rebalancing: Fund managers may adjust portfolios to improve year-end performance metrics, adding to market gains.
New Year Expectations: Investors may be positioning themselves for a strong start to the new year, contributing to the rally.
While the Santa Claus Rally has generally held up over time, various factors can have an influence, especially in volatile markets. Geopolitical tensions are elevated, the Federal Reserve’s final meeting of the year could possibly shift the interest rate trajectory for 2025, and the markets are at or near all-time highs. We’ll just have to wait and see if the Big Red Guy makes an appearance on Wall Street this year.
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