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Has the Santa Rally Officially Begun?

24 December 2021 Amega

Although there is historical precedence that stocks rise at Christmas time, there is no statistical evidence on whether the Santa Rally of 2021 has already begun if one uses the official approach.

Since we finally do head to what can be officially labeled as the Santa Rally of 2021, we must make a few distinctions about the Santa Rally using behavioral economics and past performance.

Is Santa here?

As markets are trading at all-time highs as we speak, Santa is undoubtedly on his way.

It is becoming more evident that investors decided to become part of the seasonal phenomenon. It’s early, based on the official Santa Rally involving only the last five trading sessions of the year and the first two, but we can’t ignore what the market is telling us. There have been Santa Rallies starting in the middle or even early December in anticipation thereof. However, this year seems slightly different given the uncertainty around covid.

Officially, since 1950 the market has averaged a 1.3% gain during Santa Rallies. It will be interesting to watch what the returns this year will be.

However, none of the recent returns are making the books, as the official Santa Rally has not started yet!

What is the Official Santa Rally?

The simple answer might surprise a few, but the Santa Rally is a seasonal event caused by investor greed – during the Christmas period. There are several reasons why investors turn a little more greedy closer to the end of the year, and to be fair, most do contribute to the Rally.

For one, investor behavior is affected by optimism around increased retail sales. We all get our Christmas gift by the end of the year, don’t we? In addition, many investors wait for institutional traders to go on holiday so that they can finally make their move into a less liquid and manipulated market to gain. Furthermore, some of the rises can be attributed to those institutions parking their money to safe-haven bonds, resulting in weakness in US yields, then the dollar, and this is therefore reflected in the prices of stocks. Finally, there is also the end of year effect where companies are often expected to have done well through the running year, making it possible to increase investor confidence going into the next.

Main Driver of Santa Rallies

Although we cannot attribute the Rally to one specific factor, we can say that what has really been the main driver of the stock market Christmas phenomenon is not the end of the year as much as it is the beginning of next, known as the January Effect.

The January effect is a stock market event caused by the expectation of reentering the market at lower prices – buying the dip – in January. The reason for prices being driven lower in the first place is tax-related selling by year’s end in an attempt to remain compliant with IRS’s capital losses rules. That involves corporations acting on their tax strategy and closing the year’s books.

But then why did markets start rallying in December, you might ask? This is due to people being greedy! It’s the psychological effect that gets investors to buy in early in December before it’s too late to invest. According to the official version, it’s not too late.

How to Spot a Santa Rally

There is no easy way to spot one until it starts. It is more of a time-related event than pattern-related. But as a rule of thumb, investors will wait for a significant market bottom before entering. Sometimes it happens to be earlier than later in December; some other times – 25% of the time to be precise – it does not happen at all.

Since the Santa Rally is a statistically supported event seen since the 1950s, it is more important to remember that markets rally every three out of four years. However, note that statistics are based on this year’s last five sessions and next year’s first two. Not Black Friday or December 15.

This year, for example, the SPX made a low on December 3, soaring to an all-time high on the 16th only to fall back to December 3rd lows, and it only started rising on the 20th. Officially, the above price action is of no statistical importance to determine the gains or losses of the 2021 Santa Rally.

Starting Monday, the countdown to January 4 begins. What will the official runup end up being this year?

Closing Remarks

Despite the gains associated with high volatility trading, investors trying to take advantage of the Santa Rally should consider the risks too. In theory, Santa is not here yet, he’s coming, and the markets prepare to welcome him. Do you believe in Santa?

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