All you need to know about Santa Claus Rally

What is a Santa Claus Rally?

This is a term given to the phenomenon of a rally in the stock that usually happens in the last week of December in a year and the first two days of January the following year.

Is it real?

The Santa Claus rally theory originated on the US markets. According to news reports, the US markets had seen a Santa Claus rally in thirty-four years out of the last forty-five with an average return of 1.4 per cent. The market behaviour at the end of a year and the beginning of a new year is more due to market sentiment and other factors. This makes the phenomenon happen most of the years and looks to be real. But market participants should be aware that this could just be a temporary movement in the market and not indicate the market performance for the following year.

Does it pertain only to the US markets ?

The US is considered a market driver. That is, any strong rally or a sell-off in the US markets that happens overnight (when other markets like those in Asia are closed) will impact the Asian and other markets the next day. This applies to the Santa Claus rally also but with some exemptions depending on the conditions prevailing on the local markets. Reports show that India has witnessed a Santa Claus rally in seven out of ten years.

What causes it?

There are several reasons cited for the rally to happen. Firstly, big institutional investors mostly stay out of the market as the world enters the year-end holiday season. This makes retail investors a major participant in the market. The sentiment of retail investors remains hugely positive, and they invest in stocks for the new year. Year-end and festive bonus in the US leaves more money in the hands of the people, which flows into the stock markets at the beginning of the new year, causing another phenomenon named the January effect.

What is the January effect?

The positive sentiment at the beginning of the new year makes the Santa Claus rally extend through January, the first month of the year. Why so? As mentioned above, the year-end bonus flows into the markets at the beginning of the new year. Secondly, investors who would have exited the market with a loss will start coming back into the markets. Thirdly, the institutional investors also return to the market after their year-end vacation.

Will it manifest this year?

In the US, it looks like it will. Based on Technical Analysis, on the charts, the Dow Jones Industrial Average (35,950) looks positive after a strong bounce last week before Christmas. This has left the doors open for the index to move up to 37,000, about 3 per cent rise from here. However, will this rise happen in January, thereby creating the January effect? That will depend on how other external factors evolve.

There is also room for a Santa Claus rally in India, but it could be short-lived. Because Indian markets are not looking as strong as the Dow Jones on the charts, and the trend has been down over the last three months. So even if a Santa Claus rally is seen, the impact of the January effect if it happens in the US may not get reflected in the Indian indices.

How should investors prepare for this rally?

All the market phenomenon, such as the Santa Claus rally, January effect etc., are not a given. They should not be considered as an indication of the market direction. Investors should always approach the market regarding the broader picture and the other external factors that can impact the market.

This year, even if we see a Santa Claus rally in the next two weeks if the Omicron concerns increase or any other uncertain events happen, it could then spoil the market sentiment and trigger a sell-off going forward. So, make sure to take all these market theories and phenomena as a pinch of salt because market will always behave in its own way.

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