The Santa Claus Rally: Explaining Wall Street's Christmas Cheer

Children who celebrate Christmas might dream of Santa Claus visiting their homes with, as the old song goes, "lots of toys and goodies on his sleigh." Wall Street pros, too, often anticipate a "goodie" from old St. Nick, but they've got something more specific in mind: the Santa Claus rally.

Named after its proximity to Christmas, the Santa Claus rally is defined by The Stock Trader's Almanac as the tendency of the S&P 500 to experience gains in the last five trading days in December and the first two in January. Since 1950, the index has delivered an average return of 1.4 percent during that period, according to the book's author, Jeffrey Hirsch.

The phenomenon, Hirsch said, is spurred in part by the fact that small investors often pull back from the market during the holiday period, while some finance professionals keep right on trading. The latter can seize the moment to go bargain-hunting and grab "beaten up" stocks.

"While everybody else is on vacation, those that are left to man the fort while the market is open during the last week of the year tend to buy up stocks," Hirsch said. "There's a general bullish bias during that seven-day trading period."

A couple of other factors may also be at play. In an article last year in the Journal of Financial Planning, finance professors Srinivas Nippani, Kenneth M. Washer and Robert R. Johnson suggested that holiday cheer could be pushing stocks up.

"Investors may be more optimistic during the Christmas holiday season, and their optimism might cause them to be bullish on stocks," they noted.

Moreover, companies and governments may be less likely to announce bad news during the holidays, they said. The lack of bad news could also contribute to investor optimism.

But the authors also discovered something that might surprise Santa Claus rally believers — the phenomenon exists in countries where Christmas is not widely celebrated, namely Japan, Singapore, India, Indonesia and Taiwan. There, too, stocks tend to rally in the last five trading days of December and the first two of January.

"We found it kind of remarkable that it did occur throughout the world," said Johnson, who is the president and CEO of The American College of Financial Services.

What might explain the global trend? Johnson said it's difficult to prove an exact cause, though it is possible that other markets might simply be influenced by what happens in the U.S.

"The markets are interconnected, now more than ever," he said, "And the fact is the U.S. markets tend to lead other markets."

Of course, as with any trend, there are exceptions. There were 15 occasions when the Santa Claus rally failed to deliver, according to The Stock Trader's Almanac, including the most recent two holiday seasons as well as in late 2007 and early 2008 during the lead-up to the financial crisis, and just before the dotcom bubble burst in the 1999-2000 holiday period.

Hirsch says that when Santa skips his trip to Wall Street, that can be a warning sign of a tough year ahead. Hirsch's father, Yale Hirsch, who penned the original Stock Trader's Almanac before his son succeeded him in producing the annual volume, crafted a rhyme to describe the rally's potential implications for the market. "If Santa Claus should fail to call, bears may come to Broad and Wall," he wrote.

But both Jeffrey Hirsch and American College's Johnson stress that investors must take other factors into consideration when making investing decisions rather than focusing just on the absence (or presence) of a Santa Claus rally.

"If you're suggesting that one factor is all that's influencing those returns," Johnson said, "that's over-simplifying."

Ultimately, those investing during the holiday season should take the same precautions they would take at any other time of the year, including doing their research and consulting financial professionals. After all, Christmas comes but once a year, but your portfolio is for life.