Cold Weather - Warm Returns? Joe Scott-Soane

Financial markets can be very complicated and volatile. Sometimes a news story will whip the market up into a panic and other times investors are seemingly lulled into a false sense of security. While these kinds of swings can be impossible to predict, some market behaviour oddly seems to recur around the same time every year. 

As we leave the Christmas period behind us and start the new year, it seems like a good time to reflect on the phenomenon commonly known as the “Santa Claus Rally” and “January Effect”. The Santa Claus Rally is the term given to the quick rise in stock prices in the week leading up to Christmas before the holiday period starts. After this, prices are generally perceived to be pretty flat until the new year. 

Of course, Santa is not likely to blame for these movements and there isn’t one fixed explanation for the phenomenon. Some attribute it to the spending of newly earned Christmas bonuses (for those lucky enough to get one) while others say that it could be down to the positive market sentiment surrounding the holidays and the expectation of increased economic activity moving into the new year.  

Similarly enough, the January effect is the perception that stocks rally over the month as people go into the new year. Some point again to year-end bonuses and others say this is caused by the recovery from tax-loss related selloffs that happen early in December as participants re-enter the market the following month.  

On the other end of the year we have the summer lull where markets are perceived to have less trading volumes and even a potential fall in valuations. This is a bit more of a vague effect and doesn’t have as catchy a name as the last two effects, but this lull is assumed to be down to big market participants taking their holiday over the period which generally leads to a quietening down in markets. 

The real question is how accurate are these observations? They certainly don’t occur every year like clockwork. If we use the S&P 500 as an example, since 1950 there have been rallies in the final week of December in around 60% of cases while there have been January rallies in around 55% of cases since 1900. Overall, it’s not a bad ratio but it’s also not that much better than your odds on the flip of a coin.   

While it’s interesting to theorise about the reasons for these occurrences they certainly aren’t a guarantee and there is plenty of contrary evidence to their existence. Does the Santa Claus rally take place in the last week of December? The week leading up to Christmas? Different measurements and definitions of positive market movements can completely change the results. So, while it’s an interesting exercise in market psychology I certainly wouldn’t recommend it as a part of your strategy. The main takeaway is that time in the markets is more important than timing the markets.

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