Does the Santa Claus Rally Exist?

Last Thursday's blog was devoted to the Santa Claus rally characterized by a year-end surge in stock prices. We saw that there does indeed seem to be a rally in stocks just before Christmas so I thought that I'd research this phenomenon further over the weekend in between my holiday cookie baking marathon.

Evidence for a Christmas rally...

Using daily opening and closing prices for the past 15 years on the S&P 500 (which was as far back I was able to go), I was able to generate the following tables. Table 1 shows the price percentage gain or loss for the four trading days before Christmas Day (X-4 to X-1) and for the next six to seven days following it. Most years had four trading days in between Christmas and New Year's except for 1993 and 1999 which had five and is the reason those two years have an extra data point. You can see from the table that there does seem to be a statistically significant rally for the two to three days prior to Christmas with the second to last day (X-2) outperforming the others and at lower risk (risk is given by the standard deviation).

Table 2 summarizes several year-end trading strategies. You can see that the market rallies 80% of the time for the three days before Christmas, gaining on average 0.64%. Even better is holding onto this position and riding it out until the close of the second trading day after Christmas (from X-3 to X+2). Here, the average gain increases to 1.12% and at lower risk to boot. Nice!

...but little evidence for a New Year's rally

These tables also show that as New Year's approaches, the number of days closing in positive territory decreases. It's reasonable to expect the last trading day of the year (X+4 in most years and X+5 in 1999 & 1993) to be down since that's when most investors and fund managers exit the last of their losing positions. The first trading day of the New Year (N+1 in Table 2) is generally lackluster — possibly due to the hangover effect? But the day after that is a barn-burner, up over 0.5% on average nearly three-quarters of the time.

Conclusions

Although there's quite a bit of noise to these data, the fact that the market does rally over the Christmas holiday 87% of the time (only two down years in the past 15) is statistically significant. The best way to play it would be to enter a long position (S&P futures, index options or the SPY tracking stock) on the third or second trading day before Christmas with the intention of exiting near the close of the second trading day after Christmas. It may not be the perfect holiday gift but it's a lot better than a lump of coal in your stocking!

Comments

[xmplary:]

Interesting stats, but don't be fooled by Madoffs in Santa's clothing ;-)

2008 Dec 23 08:53 AM

[je:]

Could you narrow that down to years with a declining market for us and maybe includethose with a new president?

2008 Dec 23 08:56 AM

[Jackson Cash:]

"Past performance is not indicative of future performance"

Since we're trying to be so statistically sophisticated, perhaps the author cares to offer commentary of deviation from historical trends and what that means for longer term... 15 year bubble?

As a meat and potatoes investor, I don't have my stocking out, that's for damn sure! I'm expecting a "scrooge" decade of deflation.

2008 Dec 23 10:25 AM

[SivBum:]

Santa,

During the years cited, believe that the market was up every single year other than 1994 (-1.47%) and 2000/2001/2002; or up 11 of 15 years, better than 70% of the time.

Buy and hold strategy in disguise.

2008 Dec 23 10:59 AM

[Nikola:]

.... and this year is just an average old year.

Kids, kids, kids. Haven't we said that this year all the tricks are out the window?

2008 Dec 23 12:04 PM

[je:]

wow
what a grumpy bunch

2008 Dec 23 02:55 PM

[jepittman:]

Get used to it. Anyone who even remotely suggests a stock that MIGHT go up is met with hoots of derision along with a bevy of catcalls. Same sort of thing we heard from bulls at dow 14000.


On Dec 23 02:55 PM JE wrote:

> wow
> what a grumpy bunch

2008 Dec 23 09:52 PM

[Moon Kil Woong:]

I don't know about Santa but I do know a few fat bankers and their bag is full of red colored results.

On a factual note, although statistically you win making a short term Christmas bet, 13% of the time you loose money. If you look at the dynamics for the rally it's usually due to the holiday season not being as bad as forecasted or better. Also it is stimulated by fund managers who get new cash infusion from employees with Christmas bonuses who have nothing to do with the money. And it is topped off by Corporations who allocate profits from their last fiscal year.

I would not bet that this holiday season will be great (look around the shopping mall this season and compare it to the last one). I would not bet on big mutual fund deposits, most mutual funds, especially hedge funds are hoarding cash to pay off the clients withdrawing their funds. And although corporations made money this year, they are not likely to be spending it gambling as much as making sure they have enough money to meet payroll, fixed income, and inventory costs.

This year when money is scarce losing amy money is very very bad. In fact it is so bad short term treasuries are flirting into the negative interest zone. Proof positive about how bad it is to risk your money.

2008 Dec 23 10:07 PM