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Posted on 19 April 2011 | 4,699 views

The Santa Claus Rally is Also Known as the December Effect in the Stock Markets

The Santa Claus Rally is a phenomenon where stock prices in the month of December, generally seen over the final week of trading prior to the new year. The rally is generally attributed to anticipation of the “January Effect“, an injection of additional funds into the market, and to additional trades which must, for accounting and tax reasons, be completed by the end of the year. The Santa Claus rally is also known as the “December Effect.”

Upbeat forecasts from retailers around the holiday season also tend to put investors in a good mood. Market veterans further claim that the positive holiday cheer and good spirits that flow during this season have a way of turning even the most Bearish and pessimistic investors into hopeful ones.

Another reason for the Santa rally could be due U.S. investors’ tendency to fund 401(k) retirement accounts at the start of the year. Mutual funds, large pensions and other large investors also seek to be fully invested at the beginning of the year so as to catch the rally and eventually the Santa rally becomes a self-fulfilling prophecy.

Although the pattern of stocks rising during the holidays is pretty strong, the reasons for the rally are less clear. There are several hypotheses behind the Santa Claus Rally. The clearest reason is tax considerations for individual investors.

At some point during the month of December, the stock market will rally. The stock market performs particularly well starting around Christmas and lasting until the first days of the New Year.

The stock market will rally at some point during December  which is true but pointless, since the stock market rallies during every period of the year. There has never been any month of the calendar in which the stock market didn’t at some point stage a rally.

The average return for all non-December months since 1896, for example, is 0.5%. For Decembers, in contrast, the average return is 1.2%.

Given the variability in the monthly results over the last 114 years, it turns out that the difference between December and the other months is not significant to determine if a pattern is genuine.

What about the Santa Claus Rally and the strength between Christmas and early January? It turns out that this one does have strong historical support. In fact, it corresponds to two seasonal patterns that have been well-documented in other contexts: The so-called “turn-of-the-month” and “turn-of-the-year” effects.

In 2008, during in a clear bear market, the DOW managed to gain 6.9% between December 24th and January 6th. The stock market truly must believe in Santa!

Whatever the reason, it is clear that mid-December is a generally a good time of the year to invest in the stock market.

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