Is the Santa Claus Rally for Real and What Causes It?

What is the Santa Claus Rally? It only happens once a year, when the snow is falling and magic is in the air. We wait all year long for December to arrive.

When it finally does, there's no other time like it. Of course, if you're an investor, you know we are talking about the beloved Santa Claus rally. It happens every year from right around Christmas to the first few days of the new year.

While Christmas decor is known for being red and green, this particular week is only about the green. As in stocks going way up. 

The Santa Claus Rally

  • Is this a real phenomenon? Yes! It's actually something that has been tracked. It's been shown that the entire stock market has risen an average of 1.3% during these seven days; every year since 1950. This span of days has been shown to yield positive growth in the markets 76% of the time. Which is an incredibly high rate for any seven-day period throughout the year. 

Why Does the Santa Claus Rally Happen?

Santa Claus Rally

There's no one reason that analysts can pinpoint. However, there are several prominent theories that may have some explanation as to why this phenomenon occurs.

One theory is that the introduction of end of year bonuses for employees has led to an injection of cash into the markets that boosts performance before January.

Many investors use their bonuses to invest in retirement funds or retirement stock portfolios. Which not only adds to their investments, but generally has some end of year tax implications as well.

Another theory is that people are just in better moods. They're more positive around Christmas so they tend to buy more and sell less. Is this legitimate? Probably not.

The general investor mood isn't really a quantifiable metric. Therefore, to say that being festive has a direct impact on the stock market is a bit of a stretch. Still, the rally happens like clockwork nearly every year. So there has to be something raising the spirits of investors!

Finally, could it just be that a large percentage of institutional investors and hedge fund managers are on holiday during this time of year. That leaves the retail traders to keep buying; which turns into a frenzy?

It’s certainly possible but again, not really a measurable factor. Unless we can prove that this is the case. It could really be a combination of all of these things. But one of the more consistent reasons that's supported by actual data, is what is known as the January Effect.

What Is the January Effect?

The January Effect is a phenomenon that has seen the S&P 500 rise in over 60% of Januaries since 1928. Many believe this is in part to tax implications that hit investors at the end of the calendar year.

So many people end up selling stocks in December to reduce their capital gains. Then re-buy them again in January. A quick transaction that saves the headache of paying on high capital gains that have accumulated throughout the year.

With the increase in tax-sheltered investing options, the January Effect has been reduced in recent years and may not be as prominent moving forward.

Momentum trading can be helpful as well to the Santa Claus rally.

Which Stocks Typically Do Well in a Santa Claus Rally?

Growth and value stocks are the big winners during the Santa Claus Rally. There may be several reasons why this tends to be the case.

In general, well-established companies with high market caps just don't see large fluctuations in the price of their stock; one way or another. You aren't going to see fast profits for investors if they buy up shares of companies like Microsoft (NASDAQ:MSFT) or Apple (NASDAQ:AAPL). 

But smaller cap stocks with more volatility are where the gains can be made. If investors have some extra cash lying around from a Christmas bonus or portfolio reallocation, then more often than not, they'll take a shot on some fast growth companies. 

Fund managers also like to rebalance their funds and allocate more to growth stocks to time the January Effect. They also like to do something that's typically called window dressing.

Which puts high-performing stocks into their funds so that it seems more appealing for investors to buy into. Recognizable names are great for appearance.

As mentioned earlier, while they don't provide instant profits, these bigger companies are able to prop up the markets. Which encourages more buying.

Finally, these companies on the minds of investors during the holidays. Companies like retail brands. Or companies with potentially promising endeavors heading into the new year.

There are some good examples of this every year. But the unique circumstances of 2020 bring some obvious sectors to mind. Let’s take a look at some of the stocks that could do well this year.

Santa Claus Rally 2020

  • What's different about 2020? Obviously the COVID-19 pandemic. But what about a new administration in the White House? All of these things will have an effect on the stock market, but perhaps more importantly, what investors will look to invest in as we begin to look ahead to 2021. 

Electric Vehicles/Clean Energy Stocks 

Electric vehicles have already gone to the moon this year as the pandemic has really shifted the focus from fossil fuels to alternative forms of energy. With industry leader Tesla (NASDAQ:TSLA) being one of the most talked about stocks of the year.

They recently received their largest analyst upgrade and price target to date. EV stocks should continue to be fresh on investor’s minds; and at the forefront of retail trading.

The upcoming inclusion into the S&P 500 for Tesla, means that soon nearly every mutual fund and index fund will have a piece of the electric vehicle industry amongst its holdings. 

IPOs 

We went over the upcoming IPOs in a recent article. But because of the influx of companies debuting on the public markets at the end of 2020, look for the momentum to be pushed in 2021 as well.

Investors love IPOs. And with companies like AirBNB and Instacart on deck to debut at some point in the near future, investors should be piling into these new stocks as we turn the calendar over to the new year.

Retail 

What do we like to do during the holidays? Shop! The more time we spend at stores like Costco (NASDAQ:COST) or Home Depot (NYSE:HD), the more investors think of these as rock solid businesses when we peruse the stock market.

Revenues for stores like these are always strong during the holiday season. And with it appearing like COVID-19 will continue into 2021, many of these designated essential retailers will remain open even during quarantine or lockdown.

Costco has already handed out multiple special dividends to investors this year. Including one this past week for $10 per share on top of the quarterly dividend that it already pays. 

Stay-At-Home Stocks

Another play on the COVID-19 pandemic, as more of us continue to stay inside, the products and services we use in our homes continue to do well on the stock market.

Companies like Zoom (NASDAQ:ZM), Netflix (NASDAQ:NFLX), Docusign (NASDAQ:DOCU), and Teladoc Health (NYSE:TDOC) should continue to do well and report stellar revenues as their services become more a part of our daily lives. 

COVID-19 Vaccines 

What would be detrimental to stay-at-home stocks? The introduction of a vaccine. Which we seem to be moving closer to as companies like Pfizer (NYSE:PFE), Moderna (NASDAQ:MRNA), and AstraZeneca (NASDAQ:AZN) continue to inch closer to the development of a working vaccine.

These stocks are going to continue to be popular as we move into 2021. And investors who are optimistic for the future may want to begin their positions in these stocks at the end of the year.

Will the Santa Claus Rally Happen in 2020? 

This is a question many analysts have asked. Especially after the run-up that the markets have already had this year. The S&P 500, the Dow Jones, and the NASDAQ are at all or near all-time highs. One this is for sure, it's probably not the best time to sell a call on these stocks.

So it begs the question of whether or not we'll see any sort of big pop during the Santa Claus Rally this year. There's some optimism amongst investors as the talk of a COVID-19 vaccine has certainly lifted the spirits of people. Along with the hope of a new stimulus package. After the year we've all had, don't be surprised if we see the markets go on a nice little run to end the year on a positive note.

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