There is plethora of market myths and so-called wisdom out there. One in particular that gets wheeled out at this time every year, especially by the media, is the ‘Santa Claus Rally’. Many consider this to be simply a rally during the month of December that leads into Christmas. However, Yale Hirsch, who is widely credited with discovering the pattern has a more specific definition, which is a rally during the last five trading days of the year and the first two trading days of the next. Hirsch first published this theory in the 1972 edition of ‘The Stock Trader’s Almanac’.
Santa Claus Rally = Last five trading days + First two trading days
With so much discussion about whether or not we will see a Santa Claus Rally every year, it is worth quantifying it. Chart 1 shows this period for the Dow Jones in December, 2010.
click to enlarge
Is it real or is it a myth? In the 98 years from December, 1913 to today, the Dow Jones Industrial Index (INDU:CBOT) has been positive 76 times, negative 21 times and flat once. The average gain is 2.21% and the average loss is -1.3%, with an average overall of 1.44%. The average seven-day gain over the same time frame is only slightly positive at 0.18%.
The month of December also has a good track record with 73 positive, 25 negative and none exactly flat. However, the average loss is far larger at -4% and the average gain only slightly better than the seven-day ‘Santa Claus’ at 3.01%.
The best and worst returns are also far more attractive for Santa. His best return is 9.96% in 1918 compared to 10.56% for the whole month in 1991. His worst return of -3.62% in 2000 is far better than -23.53% for December 1914. You may say 1914 and 1918 are too long ago to be relevant to today, but I disagree. For those who remember or have read about the fall of Long-Term Capital Management (LTCM), their models used only five-years of data! When it comes to trading, the greater your sense of market and economic history, the better off you will be.
I am often dubious of ‘patterns’, but 98 is a reasonable sample size. Whether we put it down to increased spending or lower trading volumes, a hit rate of 77.5% says this is market wisdom, rather than myth (unlike its name sake) and worth paying attention to.
Unfortunately this trade only comes around once a year and if it isn’t a winner you have to wait 12-months for another shot. On that note, have a safe and happy holiday period.