Why the Santa Rally is more fact than fiction

In his novel Pudd’nhead Wilson the American writer Mark Twain cautioned about October, saying: ‘This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.’ Yet even he might have to admit to December’s festive charms, as it is easily the best-performing month over time. Since its launch in 1984, the FTSE 100 index has gained 2.2% on average in December, whereas April is the only other month to offer an average advance of more than 1%.

If you want to know why markets talk about the Santa Rally, that’s why – because the numbers back it up. Tuesday’s near-2% gain on the first day of the month will only serve to fuel hopes for further seasonal cheer as a difficult year starts to draw to a close.

Source: Refinitiv data

Quite why this phenomenon should occur is less clear.

Investors used to talk about ‘the January effect,’ as money managers put clients’ money to work and into the market in the New Year but since 2000 the FTSE 100 has only risen seven times in 20 attempts in January and has chalked up 13 losses, so that may be the end of that.

It is possible that the Santa Rally has developed because investors have looked to anticipate, the January effect, and price it in, or discount it. Anything is possible at a time when passive investing and algorithm-driven funds generate such strong flows, but another possible explanation is year-end ‘window-dressing’ by professional money managers, as they put money into the market, bid up stocks and generate a bit of extra positive performance to help appease clients and justify fees. This has been a difficult year for active money managers as indices and individual share prices have whipsawed and the November rally could leave a few laggards chasing performance as the year draws to a close.

But for all of its apparent reliability – the FTSE index has fallen just seven times in December since 1984 and only five times since 2000 – the Santa Rally is not certain to offer anything more than festive cheer. It does not seem to be reliable indicator for the coming year.

The FTSE 100 has served up 11 annual losses since 1984 and ten of those came after a gain in the December of the previous year – the only exception was 2015, whose 4.9% annual decline came after a 2.3% slide in December 2014.

If anything some of the best Decembers have led to the most treacherous subsequent years – a buoyant festive season in 1993 was followed by 1994’s Fed rate rise shock, 1989’s knees-up let investors stumble into a recession and a bear market while 1999’s party led to the hangover that came with the collapse of the technology bubble in 2000.

If nothing else, that may back up Warren Buffett’s old aphorism that: ‘The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.’

By contrast, some grim Christmases – 1985, 1990, 1994, 2002 and even 2018 – have been followed by cheerful years. Only one of the seven December drops in the FTSE 100 has set a trend for the following year, and that was 2014, when even then the UK’s leading index shed just 4.9% of its value in 2015.

Source: Refinitiv data. *2020 FTSE 100 capital return to 30 November 2020

These articles are for information purposes only and are not a personal recommendation or advice.