Santa Claus Rally

Santa Claus Rally Explained

What is the Santa Claus Rally? It only happens once a year, when the snow falls, 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 yearly, from Christmas to the first few days of the new year. While Christmas decor is known for being red and green, this week is only about the green, as stocks are going way up.

Is this a real phenomenon? Yes! It’s 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 yielded positive growth in the markets 76% of the time, an incredibly high rate for any seven days throughout the year.

Why Does the Santa Claus Rally Happen?

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

One theory is that the introduction of end-of-year employee bonuses 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 stock portfolios. This 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 and tend to buy more and sell less. Is this legitimate? Probably not.

The general investor mood isn’t a quantifiable metric. Therefore, to say that being festive directly impacts 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 many 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 it’s not a measurable factor. It could combine all these things unless we can prove this is the case. But one of the more consistent reasons that are 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 by over 60% in January since 1928. Many believe this is partly due to tax implications that hit investors at the end of the calendar year.

So many people sell 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 to the Santa Claus rally as well.

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.

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Stocks That 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 don’t see large fluctuations in their stock price, one way or another. You won’t 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. Investors with extra cash from a Christmas bonus or portfolio reallocation often take a shot at some fast-growth companies.

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

This puts high-performing stocks into their funds, making it more appealing for investors to buy into. Recognizable names are great for appearance.

As mentioned, while they don’t provide instant profits, these bigger companies can prop up the markets, encouraging more buying.

Finally, these companies are 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 look at some stocks that could do well this year.

1. Electric Vehicles/Clean Energy Stocks

Electric vehicles have already gone to the moon this year as the pandemic has shifted the focus from fossil fuels to alternative forms of energy, and industry leader Tesla (NASDAQ: TSLA) is 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 investors’ minds and at the forefront of retail trading.

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

2. 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 soon, investors should be piling into these new stocks as we turn the calendar over to the new year.

3. 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 appears that 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 it already pays.

Stay-At-Home Stocks

Another play on the COVID-19 pandemic is that 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. We seem to be moving closer 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 will continue to be popular as we move into 2021. And investors who are optimistic about the future may want to begin their positions in these stocks at the end of the year.

Final Thoughts

This is a question many analysts have asked, especially after the run-up that the markets have had this year. The S&P 500, the Dow Jones, and the NASDAQ are at all or near all-time highs. 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 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 people’s spirits, along with the hope of a new stimulus package. After the year we’ve all had, don’t be surprised if the markets go on a nice little run to end the year positively.

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