Should investors cash in on the Santa rally?

"The Santa rally is one of the more statistically robust trends," says Adrian Lowcock, investment director at Architas. "In December the stock market tends to rise gently in the first couple of weeks of the month before the Santa rally takes hold and then it rises strongly in the last two weeks of the year, which are statistically the strongest two-week period of the whole year."

Asset manager Schroders, which analysed 30 years' worth of data, found that the FTSE 100 index has been more likely to rise in December than any other month. Since 1987 the FTSE 100 has risen 83.3 per cent of the time in December. It has not just been the frequency of rises, but also the size of the gains. During that time the FTSE 100 has risen by an average of 2.4 per cent in December, the highest average gain of any month.

Investors Chronicle's economist, Chris Dillow, has crunched the numbers over an even longer period – since 1966 – and found a similar trend. He looked at the monthly returns the FTSE All-Share Index produced over that time and discovered that December was the third-highest returning month, delivering an average return of 2.45 per cent. April was the top month, with an average of 2.82 per cent, followed by January with an average of 2.71 per cent.

"But the variability around returns posted in January is huge, whereas December is not very variable," adds Mr Dillow. "Looking at it this way, December has been the second-best month in terms of variability, so the facts show that there is a Santa effect. In December it seems the market is less likely to fall. Over the past 51 years there have been only 12 falls in December – a rate of 23.5 per cent, whereas for all months since 1966, there have been falls 36.4 per cent of the time."

FTSE All-Share's monthly performance since 1966*

Source: Investors Chronicle as at 06/12/17. *Data based on returns from January 1966 to November 2017.

And the evidence is not confined to the UK. Schroders found that since 1987 global stocks – measured by averaging across the FTSE 100, S&P 500, MSCI World and Eurostoxx 50 indices – rose 79.2 per cent of the time in December. The gains delivered in December, which averaged 2.1 per cent, also made it the month of biggest increases.

Causes of the Santa rally

Several possible reasons have been suggested as to why the market tends to do better in December. Jason Hollands, managing director at Tilney Group, says: "Some technical theories suggest that momentum in the markets [around December] may be down to fund managers 'window dressing' their portfolios with stocks that have performed well and reducing cash weightings ahead of reporting periods to clients. Another factor could be hedge funds closing down short positions that have not played out as expected, forcing them to buy back shares and return them to the institutions which lent the shares to them."

The Santa rally could also be driven by generally lower trading volumes as people take time off from the markets during the Christmas period, although some think that investor psychology has an impact.

"There is a holiday effect that sees the market tend to do well in the lead-up to public holidays," says Mr Dillow. "People look forward to holidays, they get cheerful and that bids up share prices, so the market rises."

>The Santa rally is a convincing phenomenon over a long period of time, but it's not guaranteed to work

He believes the Santa rally should also be seen in relation to a pattern of better market performance during the winter months than the summer months. This seasonal investing trend has been confirmed by several academic studies. For example, a 2014 paper, which studied 109 countries, found the average return from November to April across these countries was 6.9 per cent, compared with the May to October return of 2.4 per cent.

The research undertaken by Schroders also confirmed this pattern, with June found to be the worst month for the FTSE 100 and all other major world markets. Mr Dillow's analysis found September was the worst month for returns in the FTSE All-Share since 1966, followed by June and then May.

"The market has its own form of seasonal affective disorder," he explains. "People get anxious and depressed when the nights start drawing in, in September, and that slightly depresses share prices so they are underpriced. They then rise in December due to the holiday effect. They also rise again in early spring when the lighter days make people feel more cheerful."

But the brighter days in spring and summer lead to overexuberance, which has a negative impact on share prices. Mr Dillow argues that the impact of the changing seasons influences all investors – including professionals.

"I find it a struggle that some people can't accept this idea," he says. "Halloween has traditionally been a time of anxiety and fear, while May day has always been a time of hope, excitement and fertility – it's hardwired into us. Fund managers want to pretend they are sober and not swayed by sentiment. They have to create that illusion in order to justify the fees they charge."

Will the trend hold true this year?

US stock markets have had a very strong run this year. By the end of November, the S&P 500 had achieved 13 consecutive months of positive returns – the longest unbroken run of consistent gains in 90 years. And if the Santa rally happens again this year it will be the first time in 30 years that the S&P 500 has managed a full calendar year of positive returns.  

"However, as the year draws to a close, we are starting to see modestly higher levels of volatility – albeit very measured versus history," says Benjamin Matthews, investment manager at Heartwood Investment Management. "While headlines have been dominated by declines in the FAANG stocks – Facebook (US:FB), Amazon (US:AMZN), Apple (US:AAPL), Netflix (US:NFLX) and Google, known as Alphabet (US:GOOGL) – some of the heaviest falls in early December have been among semiconductor stocks. More than likely this wobble represented profit-taking based on tech stocks' substantial appreciation this year. Semiconductors within the S&P 500, for example, have risen 39 per cent in the year-to-date ended 30 November." 

And recently investors in US markets have been switching out of the top-performing tech stocks into more cyclical companies, such as financials, that are likely to benefit from higher interest rates and proposed tax reform legislation.

"A lot of the tech shares that have done so well this year will benefit less from President Trump's tax reforms than areas like banks because, unlike more domestically based companies, they operate very globally and can mitigate taxes by having lots of overseas subsidiaries," says Mr Hollands. "So a Santa rally is possible, but it might not come in the stocks that have been the most fashionable this year."

In the UK, Mr Dillow thinks the FTSE All-Share index is likely to experience a Santa rally this year. But he is basing this prediction on the historical pattern, as short-term market predictions are almost impossible to get right.

He explains: "The [FTSE All-Share's] dividend yield is slightly above its long-term average, which suggests valuations are roughly around average and returns are around average. All of this indicates that we can look forward to about average returns. There's no reason to suppose otherwise as there's far more predictability in the market over three years, rather than one month."

But the UK's ongoing negotiations with the European Union could have an effect on whether there is a Santa rally in the UK markets. And there are worries about how UK retailers will fare in the run-up to Christmas, with the increase in inflation this year squeezing consumers' ability to spend. This could dampen any possible share price rally.

"A positive market in December is probable, but I think it will be a modest amount," says Mr Lowcock. "It will be below the average – especially as we've had such a strong run – and I think people will take a bit of profit to get prepared for next year."

Time in the market beats waiting for Santa

Although evidence shows that the Santa rally is a consistent trend, investors would probably do better by not trying to time the market. If you trade in and out of your holdings you risk racking up transaction costs, potential tax liabilities and losing out on dividends.

"The Santa rally is a convincing phenomenon over a long period of time, but it's not guaranteed to work," adds Mr Hollands. "We would never encourage people to take a one-month view of the market. You should be taking a view of at least five years if you're investing in equities – not one month. Stock markets are unpredictable and volatile over the short term."

Since 1987 the FTSE 100 has risien 83.3 per cent of the time in December

And Mr Lowcock has found that if you only invested in the FTSE 100, including dividends, each December since 1986 your investment would have grown 79 per cent, while if you had stayed invested the whole time since 1986 you would have seen a 1,387 per cent return.

Mr Dillow is convinced of the benefits of seasonal investing and thinks the sell in May, buy back after Halloween pattern of investing can make sense. But because of the costs of transacting he only applies this strategy to his pension, where he can sell and buy funds for free. And he warns that trying to time the Santa rally by only buying in December is too short-term a strategy to take. 

"I don't think these monthly anomalies are tradeable and I don't want to make month-on-month calls – especially as you've got the problem of dealing costs," he says. "The [Santa rally] is not guaranteed as there's still a nearly one in four chance of the market falling in December."

But he adds that for investors who are thinking of selling their positions in the near future, it might make sense to hold off until the springtime to take advantage of the historical pattern of stronger winter returns.

And December could be a good time for investors to review their portfolios and make sure they are well-positioned for the year ahead.

"Given that we've had a good run in markets, [the end of the year] is a good opportunity for investors to regroup, see where they've made profits, and make sure they're properly diversified in terms of sectors and regions for next year," says Mr Lowcock. "It's also important to be balanced in both growth and value styles. Growth stocks have done very well this year, but they do overshoot, so it's never a bad idea to rebalance."