Why the ducks and reindeers could be lining up for a Santa Rally

A colourful firework display
A colourful firework display

Will the stock market rise in the run-up to Christmas and New Year in what has become known as a Santa Rally? I think there’s a good chance it will.

According to spread betting company IG, from 1985 to 2015 the FTSE 100 made an average gain of 2.26% in December, and the Santa Rally phenomenon occurs around 83% of the time. So the statistics favour Christmas cheer from the stock market.

Why it happens

There are several theories about why the phenomenon happens. Perhaps it’s the seasonal goodwill of investors, say some. Others think it’s because lower trading volumes cause exaggerated swings in share prices. Then, it could be because investors are rebalancing their portfolios before the end of the year. Or maybe people are busy investing their Christmas bonuses, and that’s driving markets up. Oh no, say others, the Santa Rally is because investors are hunting for bargains before shares rise in January – known as the January Effect, but that’s for another article!

It could all just be a self-perpetuating event because investors are looking for a Santa Rally. If investors are looking for it, they could jump on any rise in stock prices in December with further buying, and so on.

IG’s back-testing revealed the biggest rises in December tend to occur around the middle of the month, say the 14th, 15th, or 16th, so we could speculate that the rally is likely to start around then. However, it could be early, late, or non-existent, so don’t bet the farm on the possibility of it happening at all this year.

The stage is set

I think the stage looks well-prepared for a rally. The autumn correction took some of the speculative froth out of the market, which I think has strengthened the potential of the upside and weakened the risk to the downside. Well-known fund manager Neil Woodford said in his recent November round-up communication that last month “marked a month of consolidation for most regional equity markets.” Consolidation in markets is good, in my view, because it takes us to what legendary stock trader Jesse Livermore used to call a pivot point. From pivot points, markets tend to move up or down, but it can also mark a point of reversal in direction, which is what we want to see for our Santa Rally.

Woodford said that in November, emerging markets rallied “following a prolonged period of pressure.” There was also, he observed, “a late-month recovery for technology stocks,” which helped the US indices to “finish in positive territory.” I think the strength in overseas markets could help buoy the London stock market, and wherever the US markets go, London tends to follow.

Woodford also pointed out the sentiment of participants in the UK markets has been driven less by economics and more by politics and the long-running Brexit saga. However, markets dislike uncertainty more than anything else, and I reckon as we get closer to the Brexit leaving date of 29 March 2019, the uncertainty will diminish by degrees. It doesn’t really matter whether we end up with a Hard Brexit, Soft Brexit, Full Brexit, Half Brexit, Remainer’s Brexit or a Dog’s Brexit, what matters is that the market knows what’s coming. Maybe Christmas spirit will propel share prices higher as the Brexit soap opera plays out.

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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.