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LIDO INSIGHTS | The Truth About “The Santa Claus Rally” | December 2021

Published 12-17-2021


By: Anish Ramachandran

U.S. equities traded lower throughout Friday to finish a volatile week of trading in the red. For the week, the S&P 500 was down approximately 2.2%, Dow Jones was down 1.3% and NASDAQ was down a little over 4%. Today’s non-farm payroll and unemployment numbers were in focus as payrolls came in light at 210k while the unemployment fell significantly, prompting questions on the implications for the Fed’s tapering timeline amid ongoing inflation worries. News of a new coronavirus variant (Omicron) broke last week sending the markets into a frenzy due to fears of lockdowns that may disrupt economic activity. As we continue to move close to the end of the year, Fed action, inflation data, and data on the effectiveness of the vaccines against Omicron are going to be tightly watched and likely determine the direction of the market in the coming weeks.

In addition to economic data and virus news, we are starting to hear the phrase “Santa Claus Rally” more and more as we wind this year down. The “Santa Claus Rally” was coined in 1970’s by Yale Hirsch, a market analyst, who noticed an anomaly of generally higher returns between the first trading session after Christmas, and the first two trading sessions of the new year. According to the Stock Trader’s Almanac, the S&P 500 has gained an average of 1.3% during the Santa Claus Rally periods. Since the inception of SPDR S&P 500 ETF (SPY) in 1993, the rally has produced gains 19 out of 28 times (approximately 68%).

What Causes the Santa Claus Rally?

The reasons for the rally are very much up for debate. One thought is that a portion of end of the year bonuses make their way into the market alongside a general feeling of optimism that a new year brings. Another common explanation is that institutional investors settle their books before they go on vacation, leaving the more optimistic retail investors to drive the market in a low liquidity environment. Finally, the most likely cause of the Santa Rally is the rally itself. People have come to expect that the market phenomenon will occur, and buy accordingly, which leads the market to make gains.

Will Santa Come This Year?

The Fed
The next two weeks will be critical for the market and could set the stage for a year-end rally. The Federal Open Market Committee meets on December 15-16, where we will hear more about the faster pace of the taper and potential rate hikes. The market has brought forward its rate hike expectations to June 2022 instead of September 2022 because of higher inflation print. But, in the last week, we have seen commodity prices slide on the back of Omicron and, despite other challenges and bottlenecks, the shipping situation is slowly improving.

There are other signs that supply chain strain is easing based on improving PMI delivery times of suppliers in Vietnam and Taiwan although government responses to the Omicron variant could easily disrupt these recent gains.
The Fed has become concerned that higher prints may raise people’s long term inflation expectation above the 2% target. As a result, the tone has become more hawkish and they are now catering to the crowd that believes the only reason why expectations have been anchored at 2% is because of the notion that the Fed will act pre-emptively to control inflation. However, if the tone does not become incrementally more hawkish at the next meeting, chances of a Santa Claus Rally will increase.

The second piece of news that has the market on edge is the Omicron coronavirus variant. News of this variant broke out last week and spooked the market on a low volume day as people feared lockdowns and economic disruption. The concern is that Omicron is more deadly and transmissible than the Delta variant and can escape vaccines. Both Pfizer and Moderna have said that they need a couple weeks to test the effectiveness of their vaccines against this variant. Anecdotal evidence says that symptoms are mild but positive data in the coming weeks on the effectiveness of the current vaccines and other treatments could be positive for risk markets.

The Bottom Line
I think the market will need better news to rally into the new year. Santa Claus is busy enough with travel restrictions and testing requirements without being asked to also provide holiday presents to investors. The market may rally regardless, but let’s not blame Santa if it doesn’t.


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