Sunday, January 16

Will there be a ‘Santa Claus rally’ in the stock market this year?

In 1897, the editor of the American newspaper Francis Pharcellus Church wrote a famous response to a young reader who wrote with doubts about the existence of a certain old man in a red suit who spent a lot of time around chimneys: “Yes, Virginia, there is a Santa Claus.”

The average investor is a little older than eight-year-old Virginia, but this is the time of year when they pose their own dubious version of this question: Will there be a “Santa Claus rally” before the end of the year? ?

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In financial press jargon, the Santa Claus rally refers to an expected increase in stock market returns at the end of the year. The reference to Christmas is actually a bit misleading, because the spike typically refers to the last five business days of the previous year and the first two business days of January.

Unlike the old man in red, there is certainly no doubt that Santa Claus rallies do exist. They have not been able to visit Wall Street only five times over the past 20 years, creating a profitable opportunity to buy stocks just before the rally starts and then sell them just before the rally ends. Not only that, the absence of a Santa Claus rally has been associate with a weaker January, which makes it an important indicator.

What explains the Santa Claus rally?

However, according to economic theory, the Santa Claus rally should not exist. 2013 Nobel Prize Winner By Eugene F Fama Market efficiency theory says that stock prices must include all available information about companies and the broader economic outlook, making it impossible for past market trends to be used to predict future prices.

In fact, there are several other explanations for Santa Claus rallies. It’s the end of the American fiscal year, when investors tend to sell some assets at a loss to claim capital gains relief. Institutional investors go on vacation, leaving more traders on the market who may be less cautious or informed. In addition to that, there will be individuals who invest their year-end bonuses, while prices can move more easily at a time when the volume of transactions in the market is quite low.

However, this is not the whole story. Just as the ancient Romans believed in the influence of the calendar in everyday life, dividing the days into glories (good morning) and vile (bad days), there is much evidence that something like that it happens in the stock markets.

In 1931 a Harvard graduate student named MJ Fields wrote an article identifying a “weekend effect”, in which Fridays tend to generate higher returns in the stock market, while Mondays are typically associated with lower returns. Since then, researchers have been able to demonstrate many other changes in returns related to certain calendar times.

According to the “January effect”, There tend to be considerable gains in the stock market in January, especially on the shares of small companies. There is a “change of month effect“, Related to the first four business days of the month, and a”holiday effect”, Where the days before the holidays attract a profitability above average. Even the time of the day It matters, as opening prices tend to be higher during the first 45 minutes of a Monday, in a kind of “extension of the weekend effect.”

So how do you square all this with the idea that ultrarational traders make decisions using all the information available at their fingertips? Behavioral economics is helpful here with its insights on the psychology of decision making, many of which come from the work of another Nobel Prize winner, Richard Thaler, which he won in 2017.

This boils down to the idea that investor sentiments can influence your trading behavior – pessimistic moods on Monday when they return to work, the uplifting feeling on Friday of the weekend ahead, and of course, joy. Christmas and the optimistic feeling of a new year around the corner.

A Christmas stocking and a sign that says 'Define Well'
Santa Claus rallies make a little more sense when you study behavioral economics.
Mata Massokosta, CC BY-SA

However, there are caveats. On the one hand, the huge increase in trading bots during the last two decades, now control More than half of US stock trading undermines the idea of ​​emotionally touchy traders. Trading bots definitely don’t get sad when they go back to work on a Monday.

More generally, we must be careful not to read too much about calendar effects. We conducted a simple experiment by looking at the correlation between stock market returns and one of our birthdays. Clearly this should be irrelevant to the FTSE and yet it turns out to be a bad trading day, with negative returns of 65% over several years. So it looks like we can add the “birthday effect” to the list of days with red letters.

What to expect this year

The charts below show the last six years results at the FTSE during the holiday season (click to enlarge). They show that Santa didn’t visit Wall Street entirely in 2015, and he didn’t always give investors an easy ride in other years either – he still had to time his purchases and sales very carefully. So even though the chances of a Santa Claus rebound are reasonably high in any given year, you need to realize that the outlook is not as rosy as historical averages might suggest.

FTSEs holidays, 2015-20

Charts showing six years of FTSE action around Christmas
Daily return of the FTSE calculated by the authors on the closing prices

So will the 2021 holiday be the season for investors to be happy? It is very difficult to predict these things in advance. Certainly, with the dark shadows of rising inflation, central banks tightening monetary policy, concerns about government debts, rising energy prices, and new waves and variants of COVID, a Santa Claus rally. It may seem like a much needed Christmas gift.

But if it does happen, be careful: once the optimism for January wears off, there are currently plenty of reasons to think that there could be more losses down the road.The conversation

Gabriella legrenzi, Professor of Economics, Keele university; Reinhold heinlein, Professor of Economics, University of the West of England, Y Scott mahadeo, Professor of Macroeconomics, University of Portsmouth

This article is republished from The conversation under a Creative Commons license. Read the Original article.

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