Understanding The ‘Santa Claus Rally’ On Wall Street

This much we know: More often than not, stocks rise during the week between Christmas and New Year’s Day.

Not 100% of the time, but enough to lead people to expect the rally and to invest ahead of it, creating conditions for — a Santa Claus rally! Since 1969, the stock market has gained 1.4% during that week. Another study dating back to 1896 showed a 1.7% gain and rising stock values 77% of the time

So should you get in now? Here’s the problem with any kind of market-timing bet such as buying ahead of a Santa Claus Rally. Sometimes it fails. That can lead you to sell just as quickly as you bought, locking in a loss.

There are lot of competing ideas about why the Santa Claus rally seems to be persistent.

One is that many of the market’s large institutional participants are out of town. What’s left are strivers hoping to make a buck, leading to more big-bet trades and a general push higher.

Another likely culprit might be fund managers. Their year is ending and whatever chance they have to improve performance is at hand. Cash sitting in a fund looks bad, so it may be that cash-heavy managers are rushing to take positions.

Another is taxes. Investors can be in a hurry to make trades ahead of the year-end to manage their tax strategy, selling in order to record losses they can write off against gains.

The result of that selling activity is energized buying after the New Year, a bump in the markets known as “the January effect.”

That makes intuitive sense. Certainly there are plenty of investors looking to game the tax system. The end of the year is their last chance to get it done.

If those investors bailed out in December, the thinking goes, it might lead other investors to snap up dumped shares as prices fall, resulting in more activity and overall higher prices at the end of the year.

The problem with all of these programmatic trading concepts is that that everyone else knows about them, too. In time, people anticipate the slumps and bumps and begin to trade ahead of them, just in case.

In turn, that preemptive trading smooths out any potential for gain while increasing the risk of taking losses.

Emotion-free

It’s one thing if you can be emotionless about the numbers in front of you. But that’s not how human beings are wired. If you buy expecting prices to rise, it feels that much worse when things don’t go the way you expect.

Meanwhile, if you choose to ignore the supposed surefire trends and just contribute steadily to your investments, a funny thing happens — you get the bumps upward anyway.

Investing on autopilot means you are pay little or no attention to the day-to-day prices of your investments. If they happen to fall as you contribute and rebalance, that’s a win. You are buying more cheaply.

By failing to pay attention to the current price, you also reduce the risk of overreacting and selling out at a lower price. That protects you from losses you do not need to take.

As with all supposed market trends, the Santa Claus rally is one to ignore roundly. Better to review your periodic, automated investment levels and proceed into the New Year blissfully invested and unaware, but winning Christmas just the same.