Do You Believe in the Santa Claus Rally?

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

At this time of year, you often hear about a seasonal Santa Claus rally that many believe dependably sends the stock market higher from Christmas to New Year's Day. But with the Dow Jones Industrials (DJINDICES: ^DJI  ) having set record highs all year, you might think it's greedy to expect Santa to deliver yet another gift for stock market investors. Should you believe in the Santa Claus rally? Let's look at history to see whether you can rely on a stock market pop in the last week of the year.

What history says about Santa Claus
To test the Santa Claus rally theory, I looked back at data for the Dow Jones Industrials going back to 1970, which includes 43 years' worth of holiday-season closing values for the Dow. When you take the change in the Dow's closing value between the last trading day before Christmas and the first trading day after New Year's, the yearly results support believing in the Santa Claus rally phenomenon.

Specifically, the following results point toward a Santa Claus rally:

  • The Dow rose during the holiday period in 29 of the 43 years, more than double the 14 years in which it dropped.
  • Moreover, the average gains during winning years were a lot higher than the average losses during losing years. The Dow averaged a 1.73% gain in the years in which it climbed during the Santa Claus measuring period, compared to a 1.07% drop in losing years.
  • More recently, the Santa Claus rally has worked for five years in a row, with last year's period producing a more than 2% gain.

Curiously, though, a pair of recent results point to the seeming inconsistency of the Santa Claus rally. During 2007-2008, after years of bull-market gains, the Dow posted its worst drop out of the 43 years, falling almost 4% in the early stages of what would eventually become the market meltdown of 2008. Yet in the midst of the financial crisis in 2008-2009, the Dow had its best Santa Claus rally performance, climbing almost 7% in what turned out to be a brief respite between the substantial losses in the fall of 2008 and the market's hitting its lows in March 2009.

Be safe about Santa
As with any seasonal indicator, believing in the Santa Claus rally doesn't mean that it will happen every year. But with popular explanations ranging from the use of year-end bonus money to invest to generally favorable sentiment, if believing in Santa is what gets you to invest in the market, then it's a good motivation to get you started toward reaching your financial goals.

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