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 and the first two days of January.
Is it real?
The Santa Claus rally theory originated with reference to the US markets. The US markets have seen a Santa Claus rally in 34 years out of the last 45 with an average return of 1.4 per cent. The market behaviour at the end of a year and at the beginning of a new year is more due to market sentiment and a few other factors. This makes the phenomenon appear more frequent and real. But market participants should be aware that this could just be a temporary movement and is not an indication for the market performance for the next year.
Does it pertain only to the US markets?
The US is considered the 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 have an impact on Asian and other markets the next day. This applies for 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 of the last 10 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 the retail investors major participants in the market during this time. 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 as the January effect.
What is the January effect?
The positive sentiment at the beginning of the new year extends the Santa Claus rally through January, the first month of the new 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 start coming back into the markets. Thirdly, institutional investors also come back 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 the new year thereby creating the January effect? That will depend on how other external factors evolve.
In India, too, there is room for a Santa Claus rally but 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?
There is no certainty about the Santa Claus rally or the January effect. They should not be considered as an indication of the market direction. Investors should always approach the market considering the broader picture and the other external factors.
This year, even if we see a Santa Claus rally, if the Omicron concerns increase or any other uncertain events happen, it could spoil the market sentiment and trigger a sell-off.
So, make sure to take all these market theories and phenomenon with a pinch of salt. Because market will always behave in its own way.