Santa Claus Rally and January Effect

Santa Claus Rally 

A Santa Claus rally is a jump in stock prices, observed in the final five trading days of the year, typically starting a day after Christmas and going into the first two of January. Historically, this seven-day period has brought good news for investors, giving them another reason to cheer during the holiday season.^[1]

Why is that, you might ask? Here are some thoughts:^[3]

Some suspect that the Santa Claus rally is a result of general feelings of investor optimism around the holidays. Others point to the fact that many institutional investors, who tend to be more pessimistic about the markets, go on vacation around the holidays and leave the market to retail investors who are often more bullish.

Other explanations include the investing of holiday bonuses, lower trading volumes around the holiday season, end-of-year tax considerations for institutions and holiday consumer spending boosting sales. Moreover, some say that the Santa Claus rally is a result of people buying stocks in anticipation of a rise of prices in January – a phenomenon known as the January Effect.

No matter the reason, this seven-day trading period is the second-best stretch for equities at any point in the year, with an average 1.3% gain since 1950.^[4] Moreover, the seven-day combo produced positive returns nearly 78% of the time.^[4]

January Effect

Figure 1.  January typically sees 134% of inflows (the rest of year average is 34%; Source: GS).^[2]

Figure 2.  Seasonality based on the average of 1985-2019 (excluding 2008; Source: GS).^[2]

Figure 3.  S&P 500 Index Seasonality (Source: Equity Clock).^[2]

Relationship Between Liquidity, Volatility, and Technical Analysis

Based on his long-term experience, Justin Bennett warned that:^[6,7]

• Liquidity affects technical analysis
• The more liquid a market is, the more reliable the technical is likely to be.
• The decrease in liquidity around the month of December means that technical patterns become less effective. Markets also become prone to false breakouts.
• The same can apply to Fridays when volume is lighter. If a market does break a key level just before the weekend, you may want to think twice before trading it on Monday.
• Volatility can also affect the reliability of your analysis
• You want to be careful when using a candle’s high or low that was the result of an extremely volatile session. Chances are the price will vary between brokers, making it an undesirable candle to use as part of your analysis.

References

1. Jeffrey A. Hirsch. “The Little Book of Stock Market Cycles.” Page 170. John Wiley & Sons, 2012. Accessed Dec. 10, 2021.
2. Skew, gamma, seasonality, low liquidity - say hello to the squeeze
3. What is the Santa Claus rally?
4. LPL Research, “Do You Believe In The Santa Claus Rally?” (December 2020)
5. Chart Advisor: Santa Claus Rally
6. How Are Market Liquidity and Volatility Related?
7. How Volatility Can Sabotage Your Technical Analysis