The holiday season is not only a time for festivities but also a period when the stock market exhibits a unique phenomenon known as the Santa Claus Rally. In this article, we’ll delve deep into the Santa Claus Rally, examining its history, significance, and strategies for investors. We’ll also explore its impact on various US stock indices and major international stock indices. The Santa Claus Rally is one of many calendar effects in the stock market which can be profitably traded once you know the signals and the timing!

What is the Santa Claus Rally?

The Santa Claus Rally, also known as the “December Effect or the End of Year Rally Effect”, is a phenomenon in the stock market where there’s a surge in stock prices during the last five trading days of December and the first two trading days of January. It’s as if Santa himself is bringing gifts to investors in the form of market gains.

Remember that it was not until 1870 that December 25^th was declared a federal holiday in the United States. Since then, Christmas Day has always been a federal holiday in the US, which was adopted internationally soon after. The days over the Christmas period have their unique charm – Not only for people but for the stock market, too.

Understanding the Santa Claus Rally Definition

The Santa Claus Rally is indeed a unique phenomenon in the stock market. It does share some similarities with other seasonal effects in the stock market, such as the January Effect or the Ultimo Effect, but it also has its distinctive characteristics.

The Santa Claus Rally stands out due to its specific timing, occurring during the last five trading days of December and the first two trading days of January. These are the general trading days. We will see that these dates are not fixed, but one of the most robust. It’s characterized by positive market sentiment driven by the holiday season’s spirit. This rally is traditionally associated with gift-giving and optimism, which tends to inspire investors.

The psychological factors behind the so-called Santa Claus Rally include the collective optimism and positivity that the holiday periods bring. Investors often feel more confident, and this sentiment can influence their investment decisions. However, it’s important to note that this isn’t solely a psychological phenomenon; financial factors also influence it.

There is a saying that money moves the market. The rally can be partially attributed to year-end bonuses and tax considerations. Investors often receive year-end bonuses, which they may choose to invest in the stock market. Additionally, some engage in tax-loss selling in December, creating opportunities for others to enter the market.

Historically, the Year-End Rally has shown positive returns more often than not. This consistent performance has further cemented its reputation as a unique market event. In other words, there may also be a self-fulling prophecy factor included. This does not mean that there is a gain guaranteed, as we will see later on, but the return statistics are fairly promising and robust.

We can say that the Santa Claus Rally is a seasonally-driven phenomenon, with its distinctive timing, positive sentiment, and historical performance trends. While psychological factors play a role, they are also influenced by economic considerations and historical patterns that set them apart from other seasonal effects in the stock market.

Where and When Does the Santa Claus Rally Start and End?

The Santa Claus Rally typically commences during the last five trading days of December and extends into the first two trading days of January. The rally period is typically quite short – just 7 days.

This seven-day window is traditionally the heart of the rally, where investors tend to see an uptick in stock prices. However, it’s important to note that the specific dates may vary slightly from year to year due to market holidays and trading schedules.

The robustness of the trading dates and the significance of adhering to this period are noteworthy. Investors have historically observed that this specific time frame aligns with positive market sentiment, making it a prime investment opportunity. While some may consider entering the market earlier or exiting later, deviating from the traditional Santa Claus Rally window may not yield the same results. As systematic traders, it is our responsibility to do our analysis.

Source: Amibroker (Data from Norgate Data)

The numbers send a clear message – Entering on the 5^th last trading day of December and exiting on the 2^nd trading day of January results in the most promising risk-risk profile. So yes, we stick with the general Santa Claus Rally days.

The Significance of Santa Rally in the Stock Market

The Santa Claus Rally holds profound significance in global stock markets, but the strength of this phenomenon varies across different countries. Traditionally, the United States has been viewed as the powerhouse of the Santa Claus Rally, with the belief that it boasts the most substantial market gains during this festive season. However, recent years have seen a shift in this perception, with international stock markets, such as Hong Kong and Australia, outperforming their US counterparts significantly.

The significance of the Santa Claus Rally is undeniable across these global markets, and each region brings its unique flavor to this festive phenomenon. While the United States has a strong historical connection to the Santa Claus Rally, it’s essential to acknowledge that international stock markets, such as Hong Kong or Australia, have shown remarkable strength in recent years, challenging the perception that the US is the sole frontrunner.

In summary, the Santa Claus Rally continues to be a significant event, but investors should be mindful of the evolving global landscape as these patterns may change over time.

Santa Claus Rally by Year: A Comprehensive Analysis

Analyzing the Santa Claus Rally on a year-by-year basis provides valuable insights into its performance under various market conditions. This analysis allows us to understand the rally’s strength in different scenarios and the significance of diversification in trading strategies. This means it is worth exploring trading the seasonal effect not only on a single market but on a portfolio of international markets.

A good start is to evaluate the strength of this seasonality in different market conditions.

• Bull Markets: During strong bull markets, the Santa Claus Rally often demonstrates robust performance. Investors, already optimistic about market conditions, enter the holiday season with a positive outlook. The rally can lead to additional gains, making it a favorable period for investors.
• Bear Markets: Unlike what you expect during a bear market, the Santa Claus Rally demonstrates pronounced strength during weak market environments. Investors may approach the holiday season with caution, but the data suggests the opposite. The Santa Claus Effect shows consistent strength during markets with high uncertainty. One reason may be that it can still provide a glimmer of hope and a temporary respite from a downward-trending market.
• Sideways or Range-Bound Markets: In sideways or range-bound markets, the Santa Claus Rally may offer opportunities for short-term gains. Investors look for stock price movements within the established range, aiming to capitalize on holiday sentiment.

In summary, the market conditions do not appear to have a clear pattern in their impact on the Santa Claus Effect. However, we can see consistent weakness through all major stock indices from 2014 to 2016—a period with low volatility and low to moderate positive returns.

On the other hand, diversification may play a significant role in navigating the Santa Claus Rally across various market conditions. A diversified portfolio with stocks from different sectors and regions can help manage risk and capture potential gains during the rally. When one market segment performs poorly or one market, diversification allows investors to offset losses with gains in other areas.

Santa Claus Rally in a Global Stock Market Portfolio: Its Impact

The Santa Claus Rally isn’t confined to the borders of individual countries; it extends its influence to international stock markets. Understanding its impact on a globally diversified stock market portfolio is crucial for investors looking to capitalize on this unique phenomenon.

Here’s how the Santa Claus Rally can affect a global diversified stock market portfolio:

• Diversification Effects: The rally’s performance in various international stock markets can offer diversification benefits. When one market experiences a win during the Santa Claus Rally, others might see more muted or even negative results. Diversification can help mitigate risks and enhance portfolio stability so that losses can be reduced or neutralized on an absolute level.
• Higher Likelihood of Winner Positions: A global diversified portfolio is more likely to contain winning positions during the Santa Claus Rally. Since the rally traditionally results in positive market sentiment, having exposure to multiple markets increases the chances of having profitable positions within the portfolio. This is particularly true, as we have seen above, that the hit rate, the chance of having a positive outcome, is well above 70% on average for the Santa Claus Effect on international stock markets.
• Risk Mitigation: Including multiple international markets in a diversified portfolio can mitigate risk. Meaning that the chance of reducing the maximum drawdown is high. When some markets experience losses during the rally, the winners can offset the losers, enhancing the portfolio underwater curve.

Overall, we can be assured that the Santa Claus Rally in international stock markets offers opportunities for diversification and risk reduction within a global diversified stock market portfolio. This not only enhances potential returns but also contributes to a lower-risk profile, making it a significant consideration for investors seeking to optimize their portfolios during the holiday season. This is the theory. So, let’s dive into some analysis now.

Our global portfolio consists of the above six global stock markets. Canada, USA, Germany, United Kingdom, Hong Kong, and Australia. Constructing an equal-weighted portfolio enhances the overall risk-return profile of the Santa Claus rally. Let’s backtest our trading strategy to see how it performs.

Strategy I: Global Equal-Weighted Portfolio

• Annual Return: +1.66%

• Exposure: 2.67%
• Risk-Adjusted Return: +62.46%
• Max Drawdown: -8.03%
• CAR/MDD: 0.21
• Average Profit Per Trade: 1.77%
• Profit Factor: 4.41

Equity Curve of Santa Clause Rally Trading Strategy

Source: Amibroker | 2000-2023 | ETF SPY, EWC, EWG, EWU, EWA, EWH

Underwater Curve

Source: Amibroker | 2000-2023 | ETF SPY, EWC, EWG, EWU, EWA, EWH

Yearly Return Statistics

Source: Amibroker | 2000-2023 | ETF SPY, EWC, EWG, EWU, EWA, EWH

The simple approach is a promising start. It was expected that the overall results would be somewhere in the middle of the above markets. Let’s incorporate some risk management and a selection process for the number of total assets held.

Strategy II: Enhanced Global Equal-Weighted portfolio

In this enhanced version, we do not trade all six markets but only the four markets with the most promising momentum risk profile. This simple rule ensures that you are more likely to be invested in the current momentum strongest markets. It pays off to be a little bit more selective. Position sizing for this strategy is 25% per trade.

• Annual Return: +2.04%

• Exposure: 2.67%
• Risk-Adjusted Return: +76.34%
• Max Drawdown: -7.47%
• CAR/MDD: 0.27
• Average Profit Per Trade: 2.16%
• Profit Factor: 6.08

Equity Curve

Source: Amibroker | 2000-2023 | ETF SPY, EWC, EWG, EWU, EWA, EWH

Underwater Curve

Source: Amibroker | 2000-2023 | ETF SPY, EWC, EWG, EWU, EWA, EWH

Yearly Return Statistics

Source: Amibroker | 2000-2023 | ETF SPY, EWC, EWG, EWU, EWA, EWH

This strategy already looks more promising. The sample size is admittedly fairly small. So, in our final version, we take our trading system to the next level.

Strategy III: Global Santa Claus Strategy Portfolio

In our final analysis, we apply the current approach to a true international stock market portfolio consistent with 27 global markets. We cover North America, Middle America, and South America, as well as Europe and Asia. We also added a trend filter criterion for the entry to ensure that the recent short-term price moment has been positive. Finally, we increase the investment level to a possible 200%. Thus, having the option of a leverage factor of 2.

• Annual Return: +5.10%

• Exposure: 2.56%
• Risk-Adjusted Return: +199.09%
• Max Drawdown: -12.22%
• CAR/MDD: 0.42
• Average Profit Per Trade: 2.87%
• Profit Factor: 7.78

Equity Curve

Source: Amibroker | 2000-2023 | international ETF universe | 2x leveraged

Underwater Curve

Source: Amibroker | 2000-2023 | international ETF universe | 2x leveraged

Yearly Return Statistics

Source: Amibroker | 2000-2023 | international ETF universe | 2x leveraged

As you can see, there are some years of negative returns for this strategy; however, since 2000, 83% of years gave positive returns, so this seasonality pattern is a fairly accurate market predictor, and at times these year-end rallies can give a sustained increase in market prices.

In conclusion, the Santa Claus Rally is a unique and potentially extremely profitable event in the annual stock market calendar. Whether it is the holiday spirit, holiday spending, or year-end portfolio restructuring doesn’t really matter – what matters is there is a strong tendency for stock markets to rise over the final few days of the year.

While it may not be as predictable as Santa’s yearly visit, it brings a sense of excitement and opportunity to investors as they close out the year and welcome a new one with the hope of financial success.

A robust systematic trading strategy helps to have this successful start at the beginning of the year. We presented three strategies to exploit profitably the Santa Claus Rally:

1. Global Equal-Weighted Portfolio: This strategy constructs an equal-weighted portfolio with six global stock markets: Canada, the US, Germany, the UK, Hong Kong, and Australia. It delivers an annual return of +1.66% and a risk-adjusted return of +62.46%.
2. Enhanced Global Equal Weighted Portfolio: This strategy selects the four markets with the most promising momentum risk profiles from the same six markets. It achieves an annual return of +2.04% and a risk-adjusted return of +76.34%.
3. Global Santa Claus Strategy Portfolio: This final strategy involves a portfolio consisting of 27 global markets, applying trend filtering criteria for entries and incorporating a leverage factor of 2. It delivers an annual return of +5.10% and a risk-adjusted return of +199.09%.

Regardless of whether the anticipated rally plays out this year, in the long run this does appear to be a positive expectancy strategy with a high win rate. Of course, we can’t guarantee future returns from any trading strategy, but adding this strategy to your portfolio for the Santa Claus Rally enables you to take advantage of this profitable time. The short investment period shows a lucrative risk-return profile with a high probability of success. Thus, we think this strategy is a must-have for every systematic trader or trader in general.