Monday, December 22, 2008

More on the Santa Claus Rally

Last Thursday's blog was devoted to the Santa Claus rally characterized by a year-end surge in stock prices. We saw that there does indeed seem to be a rally in stocks just before Christmas so I thought that I'd research this phenomenon further over the weekend in between my holiday cookie baking marathon.

Evidence for a Christmas rally...
Using daily opening and closing prices for the past 15 years on the S&P 500 (which was as far back I was able to go), I was able to generate the following tables. Table 1 shows the price percentage gain or loss for the four trading days before Christmas Day (X-4 to X-1) and for the next six to seven days following it. Most years had four trading days in between Christmas and New Year's except for 1993 and 1999 which had five and is the reason those two years have an extra data point. You can see from the table that there does seem to be a statistically significant rally for the two to three days prior to Christmas with the second to last day (X-2) outperforming the others and at lower risk (risk is given by the standard deviation).

Table 2 summarizes several year-end trading strategies. You can see that the market rallies 80% of the time for the three days before Christmas, gaining on average 0.64%. Even better is holding onto this position and riding it out until the close of the second trading day after Christmas (from X-3 to X+2). Here, the average gain increases to 1.12% and at lower risk to boot. Nice!

...but little evidence for a New Year's rally
These tables also show that as New Year's approaches, the number of days closing in positive territory decreases. It's reasonable to expect the last trading day of the year (X+4 in most years and X+5 in 1999 & 1993) to be down since that's when most investors and fund managers exit the last of their losing positions. The first trading day of the New Year (N+1 in Table 2) is generally lackluster—possibly due to the hangover effect? But the day after that is a barn-burner, up over 0.5% on average nearly three-quarters of the time.

Although there's quite a bit of noise to these data, the fact that the market does rally over the Christmas holiday 87% of the time (only two down years in the past 15) is statistically significant. The best way to play it would be to enter a long position (S&P futures, index options or the SPY tracking stock) on the third or second trading day before Christmas with the intention of exiting near the close of the second trading day after Christmas. It may not be the perfect holiday gift but it's a lot better than a lump of coal in your stocking!

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