Seasonal effects of the US stock market during the Christmas period.

Every Christmas, people anticipate Santa Claus arriving on Christmas Eve, driving a reindeer sled to deliver gifts.

In the Capital Markets, investors share the same hopes, as it seems that every year-end, the stock market prepares a special 'gift' for investors – the Christmas rally.

The Christmas rally refers to the potential upward trend in the stock market after December 25.

This article will detail what the Christmas rally is, why it occurs, its historical performance, and the corresponding trading strategies.

What is the Christmas rally?

The Christmas rally is one of the many seasonal effects in the U.S. stock market, referring to the upward trend that typically occurs during the last five trading days of December and the first two trading days of the following January.

This phenomenon was first proposed in 1972 by Yale Hirsch, the founder of Stock Trader's Almanac.

According to Statistics from Stock Trader's Almanac, during the 73 years from 1950 to 2022, the S&P 500 Index rose 58 times during the last five trading days of December and the first two trading days of January, accounting for nearly 80%. During the Christmas rally, the average increase of the S&P 500 Index reached 1.3%.

More importantly, if a Christmas rally occurs, it could be a sign that the stock market will perform well in the following year.

Hirsch believes that three indicators can be used to measure the stock market performance in the coming year: the Christmas rally, the performance of the first five trading days of the new year, and the January barometer (along with the market performance of the first month of the year).

If all three of these indicators perform well, then the stock market in the new year is very likely to also perform well.

Causes of the Christmas Rally

Regarding the causes of the Christmas rally, there are various opinions in the market, and there is no unified explanation. According to CFI's summary, the most common reasons can include the following points:

Absence of Institutions

Institutional investors and traders often take vacations during the last week of December, which may lead to the stock market being dominated by retail investors, who tend to have a more bullish sentiment and could therefore drive the stock market upward.

Tax-Loss Harvesting

The tax system in the United States is also one of the potential reasons for the Christmas rally.

In the United States, capital gains in the stock market are subject to tax, while capital losses can be used to offset taxes.

Therefore, many investors sell their losing stocks at the end of the year and use the losses to offset capital gains tax, reinvesting the proceeds into other assets; this strategy is known as "Tax-Loss Harvesting."

Since the deadline for Tax-Loss Harvesting is December 31, it is speculated that in the last few days of December, the behavior of investors selling off losing positions is nearing its end, and they begin to buy back, triggering the Christmas effect.

January Effect

The expectation of investors regarding the January effect may also be one of the potential reasons for the Christmas rally. The January effect refers to the tendency for the stock market to rise in January each year.

This is also a phenomenon resulting from tax avoidance. As mentioned earlier, investors may sell off losing stocks at the end of the year for tax avoidance purposes, resulting in a market decline at the end of the year. They might reallocate to other assets in January of the new year, potentially causing a rebound in the stock market.

Festive Atmosphere

Between Christmas and New Year, there is always a festive atmosphere that can make investors feel hopeful and optimistic about the new year, leading them to invest in the stock market.

Holiday Consumption

During the Christmas season, people usually receive various gifts, including year-end bonuses, which provides investors with extra funds that can be used for investing in the stock market.

How has the recent performance of the Christmas market been?

According to statistics from Almanac Trader, the U.S. stock market has experienced a Christmas rally for the past eight years, except for 2023.

In the eight years from 2016 to 2023, the S&P 500 Index rose during the Santa Claus rally period by 0.4%, 1.1%, 1.3%, 0.3%, 1.0%, 1.4%, 0.8%, and -0.88% respectively.

Although historical data shows that the Christmas rally has occurred many times, traders and investors cannot predict whether this situation will happen again. Therefore, investors should remember that past performance does not guarantee future results.

The table below shows a comparison of the S&P 500 Index Christmas rally and annual performance over the past eight years:

Will there be a Christmas rally in 2024?

What investors are most concerned about is whether the Christmas rally will come this year.

It is worth noting that as of the end of November, the S&P 500 has risen 26.47%. Historically, when the S&P 500 Index has risen at least 20% in the first 11 months of the year, there has been a Christmas rally in December 9 out of the last 10 times, with an average increase of 2.4%, and the probability of an increase is as high as 90%.

In addition, Jeff Hirsch, editor of the Stock Trader's Almanac, recently stated that Thanksgiving may mark the beginning of a strong seasonal bullish pattern in the U.S. stock market, suggesting that one should start buying small-cap stocks from the Tuesday before Thanksgiving and hold them until January 3, 2025.

From the data, the Russell 2000 rose by 9.08% in November, while the S&P 500 rose only 6.48% during the same period. With the incentive of Trump's tax cuts for small-cap stocks, the rebound in small-cap stocks is expected to continue.

Goldman Sachs, JPMorgan, and other major firms are also bullish on the Christmas rally...

Goldman Sachs pointed out that in a typical election year, the stock market rise continues into January of the following year, only starting to fade around the inauguration day on January 20. Additionally, JPMorgan's derivatives analyst indicated that the most popular options trading bets on the U.S. stock benchmark index expect levels of 6,200 to 6,300 points in December, which, starting from the end of November, means that the S&P 500 still has an increase of 3% to 4%.

Of course, no one can guarantee 100% that a Christmas rally will occur; this is actually a matter of probability.

Many investors and traders attempt to predict future trends by summarizing historical trends, but each year is an independent event influenced by a variety of factors; history does not necessarily repeat itself, and the results may be random.

Therefore, if investors or traders wish to participate in the Christmas rally, they should prepare their trading plans and manage risks, such as setting position sizes and stop-loss plans in advance.

Summary

• The Christmas rally refers to the last five trading days of December and the first two trading days of the following year, during which U.S. stocks typically experience a surge.

• The most common reasons for the Christmas rally include: the absence of institutional investors, year-end tax avoidance, the January effect, and extra cash.

• According to Statistics from Almanac Trader, the U.S. stock market has experienced a Christmas rally in 7 out of the past 8 years, and the Christmas rally has occurred every year for the past 7 years.

• No one can guarantee that the Christmas rally will occur 100%, so if investors or traders wish to participate, they should develop an effective trading plan and risk management strategy.