Ho, ho, ho…. it’s that time of year again! Will Santa come to town bearing gifts in the form of a rally in equites in the final week of the year? If you are not familiar with the Santa Claus rally, as this has come to be known as, it’s the tendency for equities to rally during the final week of the year. Several factors have been ascribed to this phenomenon, some of which include the anticipation of the broadly known January effect, trades executed for tax and accounting reasons and portfolio managers window dressing their holdings with stocks that have performed well during the year. Regardless of the cause, up until the end of 2014 the propensity for this rally to unfold has been remarkable to say the least. I documented the performance of the Santa rally back in December 2014, so I’m interested to know how things have looked for Santa’s good tidings since the last time I ran these numbers.
The Test Rules
The rules are simple, buy equites at the close in December on the first trade day that has a day of month value greater than 24. Exit all trades at the close on the first trade day of the New Year. I also included a liquidity filter to ensure we’re transacting in liquid stocks, but other than that, there are no other rules to speak of. So, did Santa’s generosity continue?
It appears Santa has been a little tight fisted of late. Although the rally continued during the 2014/2015 transition, they slowed somewhat relative to the recent past. The 2015/2016 rally was however strongly negative, which is no real surprise really given that 2016 saw the worst start to a year of trade in 18 years. Whether Santa will resume his run this year is yet to be seen, but I suspect that may well be the case.
Small sampled edges, such as Santa’s, are much more likely to be negatively surprised (as in Nassim Taleb’s turkey’s surprise on Thanksgiving Day) than large sampled edges that have broad and deep confirmation. Therefore, one would never trade something like this in isolation, if at all. Moreover, the reason for the tendency, although intuitive, is very easily changed – managers catch on and stop window dressing at this time etc. – relative to say for instance an edge that exploits market participant’s irrationality – it’s much less likely that all market participants start to behave rationally.
Until next year, have a happy, safe and relaxing break through the festive season. I wish you everything of the best for the New Year. Thanks for your support and I look forward to another year together.