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Is the Santa Claus Rally a Real Thing? Spoiler – It is!

I recently was having a conversation with a coworker where they said that the Santa Claus Rally was one of their favorite times of the year when it comes to investing. I have heard the term of Santa Claus Rally before but it’s typically on CNBC and truthfully, that’s the exact type of phrase that I purposefully tune out.

It stood out to me when my coworker said it because he’s typically a very disciplined investor but this seemed like anything but that. When he explained it to me a little bit better, I then understood his points. But before I get into those, let’s first explain what the Santa Claus Rally is.

The Santa Claus Rally is the last five trading days in December and then the first two trading days in January. So, basically, you’re trading during the holiday season. The reason that he loves the Santa Claus Rally are below:

1 – It works

Historically speaking, those last seven trading days have done very well, he said.

Personally, I was very skeptical of this because I always thought that people are trying to sell their “losers” at the end of the year so that they can minimize their taxes. At the same time, they’re also going to be selling some of their “winners” if they were down on the year to not waste any tax benefits.

Now, they could always put those funds back into other companies once they sell, but I know that many individuals will just sit on that cash because they might not know where to put it.

2 – It’s fun

He is similar to me in that watching those CNBC shows are our equivalent of watching a bad TV drama. We do it purely for entertainment but it’s fun to mess around with a small amount of money on some speculative investments that they recommend from time to time.

He said he treats it as a purely entertainment time for himself since he also will take vacation during the last week of the year and it’s just enjoyable to break his normal investing rules for a few days for fun. In that case, whatever floats his boat!

But I am here to talk about the cold hard facts with the Santa Claus Rally and then to see if it actually means anything to you, the average investor.

I pulled historical data for the S&P 500 as far back as Yahoo Finance will let me go, which is back to 1929. When I look at the average returns for those time periods, it turns out that the Santa Claus Rally actually does show some pretty strong returns!

The average Santa Claus Rally has been 1.71% over just 7 trading days! That is truly incredible. If you were to annualize those returns over an entire year, you would have made 81%…and that’s just with the share price yield. You’re not even looking at the total S&P 500 Yield that includes the dividends!

The median during this time period, which is a good way to get rid of outliers, is 1.66%, which is right in line with the average. The best returns that you would’ve had by investing in the Santa Claus Rally is 8.83% in 1933 and the worst year is -5.32% in 1932 – odd that this happened in back to back years.

Not only are the numbers there, but one of the most important things in investing is to never lose money! For 72 of 92 times, the Santa Claus Rally was in the green and you were bringing home some money. That is just an insane “win rate” where you know that your investment isn’t going to lose, or historically, the losses have been significantly more infrequent than the winning times.

I will say that one thing that I have noticed is that the average returns from the 1950’s to the 2000’s were extremely strong, so that sometimes can skew the data a little bit. Because of that, I like to also look at different time periods:

  • 1950 – 2020: 1.33% average return
  • 1975 – 2020: 1.10% average return
  • 2000 – 2020: 0.72% average return

While it is apparent that the returns significantly drop as the start date becomes more recent, 0.72% is still extremely strong. If you were to annualize that, a 0.72% return over seven trading days would turn into just under a 29% return on the year.

Not sure about you, but I would be ecstatic with that type of return every year!

So, I think it’s clear that my coworker was right – the Santa Claus Rally is a real thing. But why? Why does this work?

Truthfully, there really aren’t any good reasons that I have read. I have seen various reasons that all just seem strange to me:

People are spending more money during the holidays with their shopping

…. Ok? If anything, I would imagine that this means that people will have less money to fund their investments. They might even back down on them a little bit to help cover these payments for presents.

Another example, which is one that literally affected me today, is with my HSA. To max out an HSA, you can contribute $7100 as of 2020. I setup my account to take the same amount out of my paycheck each week so that I can ratably pull money out to max it out.

I am paid biweekly, meaning I have 26 paychecks each year, but instead of distributing the amount over 26 paychecks, I do it over 25. What this means is that I contribute an extra $10.92 every paycheck but then when I get to my last paycheck of the year, I don’t contribute anything at all because I’ve already maxed it out.

I now have a $284 “raise” as my paycheck has increased by that much (minus taxes). It really doesn’t mean anything other than it’s nice to have this extra money around the holidays, but my point of bringing this up is that I now am not investing my $284 in my HSA at the end of the year, so the demand is not continuing to increase.

Yes, I know that my $284 literally means nothing, but if others do something similar, I would anticipate contributions not being strong in late December.

People are investing in anticipation of the January Effect.

The January Effect is a very common topic this time of year in the investing world where people claim that the best performing month in any single year is January. In other words, the market is going to have the greatest return in January than it would vs. any other month.

The issue is that it’s not true!

I debunked this theory where it was evident that January is a really good month but it’s definitely not the best. As you can see below, January is really just kinda in the middle of the pack:

Now, I will say that January was never worse than the 8th best month so that’s definitely a good sign, but on average it was the 4th best performing month.

Again, not bad, but dumping your funds into the stock market in the anticipation of January being some month that just blows out all other months is not only insanely risky but it is factually inaccurate.

Tax Loss Harvesting has already taken place

I guess I could see this being a thing but it makes me a little bit curious. I mean, maybe everyone has already sold their losers and now they’re buying back into the market, but that doesn’t make a ton of sense to me.

Personally, I view tax loss harvesting as selling your losers that you might still believe in but you want the guarantee of the tax savings. Now, part of that is that you cannot sell your stocks and then buy them back within 30 days or a “wash sale” occurs, which basically means that you don’t get any of the tax advantages that you were hoping to capture.

So, if I was going to take part in this strategy, which I have done in the past and even this year as well, I typically wait until the last minute to sell and then if things still look good in 30 days, I’ll buy back in then.

Maybe some people will sell early on in the month and then buy back in during January, but that’s just not my style. But I suppose I can see how this one might have a small amount of validity as people might not want to be tinkering with their investments the last few days of the year, especially if managing a fund.

At the end of the day, all three of these reasons are just excuses to me honestly and the actual reason seems a little bit unknown.

So, you can likely make money by investing in the Santa Claus rally, but is the Santa Claus Rally also an indicator for future success in the remainder of the month in January?

The average January returns, taking out the first two trading days of the month which are included in the Santa Claus Rally, are 0.64% on average and the median is 0.50%. The highest returning month is 12.37% in 1934 while the lowest is -11.31% in 2006.

The wide variability between the max and the minimum doesn’t really surprise me as there are many more trading days in January as a whole vs. the Santa Claus Rally itself.

If you had invested in the S&P 500 every time after the Santa Claus Rally was positive and kept your money invested for the remainder of January, your average return would’ve been 0.63%.

On the other hand, if you had decided to invest after the Santa Claus Rally was negative then your average return would be 0.63%.

So, to me – this means that there really is no difference at all and that the Santa Claus Rally isn’t an indicator of any other potential returns.

Personally, I would never invest during the Santa Claus Rally with the expectation of being able to time the market and get better returns. Of course, I will stay invested during this time, but I’m not going to add extra money to put into the market for seven trading days just to pull it out after that.

To me, that is the definition of timing the market and that’s something that I really try to avoid. Not to mention, nobody can provide any sort of definitive reasoning for why this Santa Claus Rally even occurs.

It might be easy to just turn a blind eye and just go, “who cares what the reasoning is – the data shows that it works!”

While I get that point, I will say that the history is not always a perfect indicator of future performance, and if you have no idea why something worked in the past, how are you going to have any idea if things have changed and might not work in the future?

Exactly – you won’t.

So, if you want to be like my friend, go ahead and take advantage of the Santa Claus Rally. I won’t hate you for it and I won’t blame you for it, but at the end of the day, it’s extremely speculative and very risky, so when you lose money and have no idea, that’s on you!

I actually had a conversation with my friend after doing this research and what he said was this, verbatim: “Andy, I am doing this purely for entertainment. I know I’m not going to lose all my money and it’s a way that I can have fun during my time off from work.”

If that’s your mindset, then you do you. It’s nothing more than gambling, which certainly can be fun but also is rigged for you to lose. Not sure about you, but that’s not how I like to invest.

Don’t get me wrong – I do like to invest in a risky fashion with some speculative investments, but I will always do so after some long hours of research and making sure I understand the company that I am investing in…a little more complex than just looking at historical returns!