Sometimes the best gifts are the ones that are found at the last minute (or later). And one of the best gifts the stock market gives investors occurs for seven trading days, called “the Santa Claus rally.”

This is a gift that tends to last from Dec. 24 through the second trading day of January. This trading period can be very useful to anyone, even those who aren’t going to trade during this time frame, because it can be used as an indicator. 

Because the time frame is almost always a bullish one (e.g., the S&P 500 has moved higher 12 out of the past 15 years), you can get a sense of how bullish or bearish the large investors really are by simply sitting and watching what happens.  

If the time period is weak, then it might be a very good indication that the market is likely to be weak in the near to intermediate term.

Will Seasonal Patterns Prevail?

Looking at the well-known, seasonally strong time frames for weakness (at any time of the year) is a pretty reliable signal of coming weakness in the market. 

On the flipside, looking for signs of strength during times that are typically/seasonally weak is a reliable indication of upcoming strength. 

December is typically weak for the first half of the month, and that’s just what we saw this year. In fact, we are seeing stock market action falling back into the typical seasonal patterns (many of which were thrown off by the recent stock market mayhem). 

For example, the small-caps have been outperforming the rest of the market lately, as we tend to see at this time of the year. (Remember, there are many more small companies than there are large ones.)

What used to be called the “January effect” has turned into the “December effect,” as investors who identified the January effect decided to try to front-run the trend in recent years.

What’s Behind the ‘Santa Claus Rally’?

Since the seasonal trends have once again become a bit more reliable (for the time being, anyway) we can use the coming “Santa Claus rally” time frame as a reliable barometer. But be sure to use it as a barometer only in the event that we see weakness where we usually see strength (not strength when we usually see strength). 

On average, the S&P 500 (SPX) has advanced 1.5% during the seven trading days beginning Dec. 24.  But typically strong seasonal periods that come immediately after a bear market has ended are typically even stronger. 

For example, December has been the strongest month over the last 40 years, averaging 1.6% gains, but that average gain changes to 3.1% when you only include Decembers that followed a bear market.

Some say the rally has to do with people already being in “buying mode” at the end of the year (considering all the gift buying that happens during that time of year). But that’s a bunch of B.S., because it’s not the people running around the shopping malls throughout December who move the markets.

Those with the kind of power that can move markets with their buying or selling of stocks have people doing their holiday shopping for them.

The truth is, nobody really knows what causes the rally. Some say it’s because of the light trading volume; some say people are selling some stocks and buying others. 

I happen to think it’s because it’s an extension of the reason why December tends to be a strong month — because people are trying to front-month the typical January rally and volume in the market is low because people are in holiday mode. 

Early January is often the strongest time of the year because you have every kind of fund investing in the market at that point. You have funds that invest yearly, semi-annually, quarterly and monthly, all making scheduled contributions at the same time. 

Whatever the reason is, it’s a good barometer to use if the market sells off, or if the rally is non-existent.

Happy holidays, folks! And keep an eye on the seven-trading-day period known as the Santa Claus rally. 

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