Will we see a Santa Claus Rally in 2023?

As the holidays approach, bullish sentiment often returns to the markets. This phenomenon is very welcome among traders and speculators, especially as it brings with it potentially interesting opportunities to make some extra cash before Christmas. So let's take a more in-depth look at the Santa Claus Rally and tell you when it starts or what to watch out for.

 

What is a Santa Claus rally?

The Santa Claus Rally is a seasonal trend in the stock market during which stocks tend to appreciate towards the end of the fiscal year. This phenomenon was first noticed by Yale Hirsch, and described in his 1972 book The Stock Trader's Almanac. Historically, the Santa Claus Rally has occurred 76% of the time between 1950 and 2019. According to the Stock Trader's Almanac, the market rose an average of 1.3% each year during this period.
 

What possibly causes the Santa Claus Rally?

While statistically it looks interesting, the markets can never predict exactly if and when the Santa Claus Rally will take place. For example, the media sometimes refer to the Santa Claus Rally as the period that begins on Thanksgiving day, a moving holiday that falls on the 4th Thursday in November in the US, and continues throughout December. According to Hirsch, the Santa Claus rally occurs in the last week before December 25 and lasts until January 2.

The week after the Christmas holidays, however, is traditionally very quiet. Which makes sense. Many market participants are taking their holidays and volumes are low. This low liquidity then creates more of a sideways movement, which can sometimes see sharp volatility swings that last a few minutes or seconds. These then tend to occur during the Asian session, where liquidity is much lower than in the London or New York sessions.

For the purposes of this article, we will understand that the Santa Claus Rally occurs 5 days before the Christmas holiday. We can see how this phenomenon has manifested itself over the last 20 years in the following figure:

_{Price changes in the SP500 index in the last week before the Christmas holidays. Source: www.investopedia.com}

We can see that in most cases in this period there was a rise in the share price, which in two cases exceeded 4%. In eight cases, however, the growth was less than 1% and in three cases there were even losses. The Santa Claus Rally is therefore a phenomenon that is statistically probable, but not guaranteed, and the amount of index appreciation during this period is highly variable.

Let us now look at the broader picture, namely the seasonality of the last quarter of the year:

_{Seasonality on the SP 500 index. Source: www.charts.equityclock.com}

We can see that the index added an average of 1.3% in October, 1.8% in November and 0.9% in December. Of course, this is just a statistic and there have been times when the index has posted losses during the period.

Why is there a Santa Claus Rally?

There are several theories behind this phenomenon, but the main reasons are basically as follows:

• Employees receive annual bonuses, and this allows them to spend more. Most of them are unlikely to buy stocks during this period, but increased spending on purchased goods will improve firms' profits in the last quarter of the year, and the market is pricing this into their prices ahead of time.
• Proponents of the theory that the rally occurs after Christmas argue that the lower trading volume during this period makes it easier for bullish investors to get the market moving.
• There are also theories that the Santa Claus rally occurs because institutional investors go on holiday during the holidays and do not actively trade during this period. This theory requires the assumption that retail investors tend to be more bullish, and when they can have a greater impact on the market, they will cause stock prices to rise.
• Another theory holds that investors are preparing for the "January effect," a separate calendar phenomenon in which some stocks tend to rise more than others in the post-holiday period in early January. The January effect is thought to result from the realisation of tax losses in December in order to pay as little tax as possible, which is done by subtracting realised losses from realised gains. Investors then buy the shares again in January.

There is a logic to all these reasons. But as we have seen, this rally does not always happen. Therefore, it is good to take into account the situation in which the markets are currently.

What threatens the emergence of a Santa Claus rally for 2023?

This year's Santa Claus Rally could be threatened for the following reasons:

• Inflation is still too high: Although US inflation has managed to be pushed down from 9.1% in 2022 to 3.7%, the August figure, it is still quite far from the Fed's 2% inflation target. Moreover, inflation rose marginally again during July and August 2023.

• Fed policy: High inflation will force the Fed to adopt a hawkish tone. Indeed, we saw this at the last Fed meeting in September when Jerome Powell did not rule out the possibility of another rate hike this November.

• US Treasury yields: The 30-year Treasury yield tested the key 5% level. This means that debt financing is therefore becoming very expensive for US companies. But high bond rates also pose a risk to equity markets from another perspective. Indeed, many investors will prefer a "safe" investment in US government bonds, which will yield an interesting stable return, to the uncertainty of volatile equities.

• A strong dollar: The dollar has broken above 107.00 on the USD index. A strong dollar is negative for US stocks, commodities and most currency pairs. The dollar is supported in its rise by hawkish Fed policy and high US bond yields.

• Real estate market in the US: High interest rates are reflected in mortgage rates. In the US, they have climbed to an average of 7.48% for a 30-year fixed-rate loan. This is obviously difficult for homebuyers, whose monthly cost of financing 80% of the value of an average home has increased by 21% compared to August 2022. Although mortgage rates are dampening demand, there is still a shortage of properties on the market, putting upward pressure on prices. This makes acquiring a home increasingly difficult for many Americans.

• Slowing China: China is the world's largest buyer of all consumer goods, and when its economy is running at full speed, the U.S. naturally benefits. But this year, the situation does not look good for the Chinese economy. And as China slows, so does the performance of many other economies. At the end of September, Hong Kong's Hang Seng index was losing 19% to its high this year. At the same time, the Chinese yuan fell to a 16-year low against the US dollar. The weak yuan is making imports of goods into China more unaffordable and putting upward pressure on inflation.

• Rising oil prices: WTI crude has reached a price tag of $95.3 per barrel this year, with Brent crude selling for nearly $96 per barrel. High oil prices have always led to problems in the economy in the past. At the very least, it pushes up inflation and makes inputs more expensive for companies. And since OPEC is sticking to its plan to curb oil production, it doesn't look like the price of oil is going to start dropping significantly.

• Geopolitical risk - war in Ukraine: The war is putting a strain on the budgets of Western countries that support Ukraine in defending their country from the Russian aggressor. The financing of Ukraine is then forcing the assisting countries to look elsewhere for budgetary reserves to cover the growing debt. After all, we have seen dramatic discussions about the debt ceiling in the US several times this year.

There are therefore more than enough fundamentals that could threaten the growth of the stock in the last quarter of 2023. As it happens, however, nothing is black and white in the markets and these contexts are not new, so the market has probably already factored them into its prices in some way. Moreover, earnings season is upon us and corporate earnings, particularly in the technology sector, which is booming thanks to the development of artificial intelligence, could give the bulls the expected boost. Traders, investors, and analysts are also keeping a close eye on the US political scene. At the moment, it would appear that a government shutdown is imminent in the US on 17/11, which would also have some impact on the markets.

Conclusion

Traders should pay attention not only to technical analysis and fundamental data in their decisions but also to cyclical trends that can bring another element to their portfolio of trading strategies. The Santa Claus Rally is one of them. However, it is important to remember that past performance certainly does not guarantee similar behavior in the future. In fact, there are a number of factors and risks that could cause this year to be different.

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