Should we believe in the Santa rally?

In the same way that their children wait on its mythical namesake, a lot of investors will head into the Christmas-New Year period hanging out for the proverbial Santa rally in equity markets. Is there logic to this legend, or can we chalk this up as another holiday superstition?

Taking a look at the last ten years, history would tend to suggest that the markets do record outsized returns over this period. Putting the highly volatile 2018 aside, mid-December through to January has typically been a strong period for stocks in both the US and Australian markets.

Over the ten years to 2017 the average gain in US shares over the period has been about 1%, and the US market has been up seven years out of ten. The pattern is even more pronounced in Australia with average gains in the order of 2% and the market up in eight of those ten periods.

As I foreshadowed, for the sake of this argument we’re going to have to consider 2018 an outlier. You might recall that share markets were quite weak right up until Christmas Eve, but then rallied before New Year, particularly in the US. So in hindsight, Santa did deliver last year, he just landed a little later than usual.

Three factors driving these seasonal gains. 

First, if you look at the typical tax patterns in the US, mutual funds and individual investors often sell shares in the lead-up to the September-October period in order to lock in losses to offset their capital gains and reduce their tax bill. Then, heading into the end of the year they have to buy back into the market.

Second, as we edge closer to Christmas there are fewer IPOs and capital raisings, but investors are usually feeling a little more optimistic coming into the end of the year and searching for options to increase their holdings. 

That dynamic, combined with the investment of Christmas bonuses, can contribute to an influx of capital over the Christmas-New Year period.

Odds are in your favour that Santa will drop in