How Reliable Are the “Santa Claus Rally” and “January Effect” Trends in the Stock Market?

If you’re interested in investing and finance, you may have heard of the “Santa Claus Rally” and “January Effect” trends, which refer to stock market trends that occur through the end of December and into the new year. This article will talk about these two phenomena and answer the questions: Are they real? Why do they happen? Are these trends reliable?

What Is the “Santa Claus Rally”? 

The Santa Claus Rally is a term that refers to a sustained increase in the stock market that happens in the last week of December and through the first couple of days in January. Specifically, it is the likelihood for “the S&P 500 to rally the last five trading days of December and the first two of January,” according to The Stock Trader’s Almanac, which is known for popularizing the term.

Many people have tried to explain the Santa Claus Rally throughout the years. Some of the possible causes include tax considerations (offsetting realized capitalized gains), optimistic feelings on Wall Street, and the influx of end-of-year bonuses being used for investments in the stock market. Many experts also tend to believe that the Santa Claus Rally is a direct result of people buying stocks as they wait for the prices to rise in January, something that’s referred to as the “January Effect.”

What Is the “January Effect”? 

The “January Effect” premise is that stock market prices tend to be higher in January (on average) compared to any other month of the year, leading to higher returns for many investors. This phenomenon is often considered to be closely tied to the seasonal occurrence discussed above一the Santa Claus Rally. 

This stock price rally in January may be due to increased buying in December, which occurs for the reasons outlined above.

How Reliable Are These Trends?

In the stock market, past patterns and results never guarantee future performance. Even though there isn’t a singular explanation for why the Santa Claus Rally happens, it has proven to be a reasonably reliable occurrence in the stock market. For example, data reported on by The Stock Trader’s Almanac showed for 34 out of 45 years (1969 to 2014ish), the Santa Claus Rally has resulted in positive returns, which is about a 75% rate of consistency.

Investment banker Sidney Wachtel first discovered the January Effect in 1942, at which point he began researching return patterns back to the 1920s. Data from the 1920s to 1990s show that higher returns were made in January than any other month, supporting the existence of the January Effect.

The January Effect has been less consistent in recent years. There may be several reasons for this, including the fact that it has become more mainstream, and thus the knowledge of the effect may have negated it. Additionally, fewer people may have been selling at the end of the year to counteract a tax loss since tax-sheltered retirement plans are more prevalent.