Santa Claus Rally: The Stock Market’s December Effect

After a meteoric stock market run-up in November 2023, traders set their sights on the final month of the year. Last month included two key market events with the FOMC meeting and the monthly CPI report. Both indicated cooling inflation and the potential for the Federal Reserve to put a pause on interest rate hikes. Market participants interpreted the data as bullish, and the S&P 500 rallied more than 8% in November, pushing the index up nearly 20% on the year entering December. 

What is the Santa Claus Rally?

The Santa Claus Rally, also known as the “December Effect,” is an observation stating that stock markets tend to have higher returns during the month of December. The phenomenon begins after Thanksgiving and gains momentum the final days of the year and into early January. The rally is typically attributed to seasonal factors such as increased consumer spending during the holiday season, yearn-end bonuses, tax considerations, and end-of-year portfolio rebalancing.

The term “Santa Claus Rally” is a seasonality trend observed by Yale Hirsch, who noticed that stock prices tend to rise in December.  Although not guaranteed, history suggests that investing in stocks at the end of November and holding until just after the new year could lead to higher returns than at other times of the year. Let’s take a look at what the data shows.

December Stock Market historical results

Studies show that the S&P 500 has risen by a monthly average of 1.5% during December since 1950. Over the last decade, December returns have been even higher with an average monthly return of 2%.

How did November’s outsized move impact option probabilities and Trade Ideas performance? Read Trade Ideas Performance: Analyzing Option Probabilities & DTE to see why November 2023 offered a fantastic opportunity to study the options market.

Stock Market's Annual Return's Impact On December Performance

Will Santa come to town in December 2023? Historical data suggests yes. Since 1950, December has had positive returns 75% of the time, with an average gain of 1.6% when the market was up year-to-date heading into the final month.

Furthermore, November was up more than 8% in 2023. The S&P 500 has an average monthly gain of 1.8% after months finishing higher 8% or more.

Volatility has been extremely low since the late October sell-off. The market bounced sharply, but perhaps the Santa Claus rally has been front-run by the strong final weeks of November? Again, the data suggests no. The stock market typically experiences positive returns during the last five trading days of December and the first two trading days of January. This seven-day stretch averages a 1.3% gain since 1970.

2024 Stock Market Outlook

Santa Claus’ arrival, or lack thereof, often protends the next year’s outlook. To quote Hirsch, ‘If Santa Claus should fail to call, Bears may come to Broad and Wall.’

Negative returns in the final days of December and early January preceded major market declines in 2008 and 2000, but do not always exhibit predictive powers, including most recently as 2015, when the S&P was down -2.3% during the seven-day Santa Claus rally, only to see the market up nearly 10% in 2016.

Either way, history has shown quantitative evidence that the Santa Claus rally is more than a colloquial term to describe what has statistically been an above-average month, specifically after Christmas through the New Year.

Option Flows and Seasonality

As stated, there are multiple opinions for why the Santa Claus rally persists. One idea is ‘Performance chasing.’ That is, the pressure to buy stocks when the market has been performing well could be why December is often stronger after the market has been up.

Others, such as Cem Karsan, recently alluded to the idea that the end of year/beginning year are ‘incredibly positive [because] when the market is up there’s a significant amount of reinvestment that goes into the market on January 1st.’ Cem also points to the options market and the fact that December OPEX is the biggest option expiration period of the year.

What’s more, volume and liquidity are typically much lighter in the period between Christmas and New Year's, making it easier for markets to move without much resistance. “There are less calendar days around Christmas and New Year's very little trading happens. Trading is dramatically lower, about 30% lower than any other time during the year, accelerating flows in the market.’

Using Seasonality for Options Trading Ideas

The end of the year brings unique opportunities for options traders looking to capitalize on historical data. One important factor is end of year/beginning of year money flow, market liquidity, and options volume. Trading volume in general tends to be lower than average between Christmas and New Years, and the important January OPEX plays a key role.

December Options Trade Ideas

If your market bias is bullish, Option Alpha’s Trade Ideas makes it easy to target high probability SPY short put spreads with positive expected value (EV) for trades expiring in January.