For those pondering a contribution to your stock portfolio, we are closing in on one of the seasonally strongest investing weeks of the year — as if the holiday season weren’t festive enough!
Seasonal investing trends should never trump fundamental analysis for the long-term investor. However, it might not hurt to at least be aware of what parts of the year tend to be weak or strong for the stock market, especially if one is thinking about buying or selling stocks in the near term.
Here’s how often this aptly named year-end investing trend proves out and how much investors can expect to gain from it.
Santa Claus is coming to town
The final trading week of the year and the first two days of January historically see stocks rise more frequently than any other time of the year. This curious phenomenon is often referred to as the Santa Claus Rally. Yale Hirsch first coined the term in the Stock Trader’s Almanac back in 1972, so this phenomenon has been occurring for a long time — likely a majority of the modern American stock market era.
According to Carson Investment Research, from 1950 through 2022, the Santa Claus period sees a rise in the S&P 500 (^GSPC 0.25%) about 80% of the time, with an average gain of 1.32%. That may not sound like much, but it’s actually quite a hefty gain for just one week. In fact, the Santa Claus week has the third-highest historical return of any seven-day period, and it’s the week with the highest frequency of gains.
Why does the Santa Claus rally happen?
The causes of seasonal patterns in the stock market, including the Santa Claus rally, aren’t known with precision. Once established, trends may be somewhat self-fulfilling, as investors buy into known strong periods and sell into weak ones.
However, there are several possible causes of the Santa Claus rally phenomenon:
- Investors generally become optimistic ahead of a new year.
- Investors may attempt to get ahead of the January Effect, when many investors put new money to work as part of their investing plan, as January is also known as a historically good month.
- Workers may put their year-end bonuses to work.
- Investors have completed the year’s tax loss harvesting, which has a cutoff date of Dec. 31.
- Professional investors go on vacation, leaving more retail investors — who tend to be bullish — to trade.
- Investors may also rush to contribute to traditional individual retirement accounts (IRAs), which allow tax-deductible contributions up to an annual limit, to reduce the taxes owed in the new year.
How often does a Santa Claus rally happen? Image source: Getty Images.
If Santa doesn’t come?
Meanwhile, if Santa doesn’t come, that could be a sign that the following year may turn into a lump of coal. Again, according to Carson Research, of the mere six times over the past 30 years that there wasn’t a Santa Claus rally and the final week of the year had negative returns, January was subsequently lower five times. Moreover, the following full year had negative returns four out of those six times.
That said, a Santa Claus rally is also no guarantee of an up year, either. While most years that follow a Santa Claus rally are positive, it’s also true that the stock market has positive returns roughly 70%-75% of the time. But there are exceptions. For instance, at the end of 2021, there was a Santa Claus rally, but the market went on to see a brutal 19.4% market decline in 2022.
Should you play seasonal trends?
While this knowledge may be helpful, seasonal trends shouldn’t necessarily influence your long-term investing plan. The stock market is inherently unpredictable, and as noted in the example above, there are always exceptions — potentially big ones. If one does attempt to time the market, investors should also take into account whether stocks are expensive or cheap, the state of the economy, and a host of other fundamental factors.
Moreover, over the long term, stock market investors tend to do well if they stick with a set strategy. While the S&P 500 is up 75% in all years since 1928, there can also be long stretches, as in the 1930s, 1970s, or 2000s, with negative or flat returns.
That said, the longer you stay in the market, the higher the probability of positive returns. If you invest in the S&P 500 and hold on for 10 years, the probability of a positive return rises to a whopping 94%. And if you stick with the S&P 500 for 20 years, those odds rise to 100%.
That’s right — based on history, S&P 500 investors have seen positive returns every time they held the index for 20 years or more, even when entering the market at the worst possible time. This is all the more reason to develop a process-driven, unemotional method of investing for the long term.
That said, if your process does dictate a contribution to your portfolio in the near future, you may want to do so before Christmas.
