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Is the Santa effect real?

The so-called Santa Claus Rally is one of investing's great mantras. But is there any truth to it, asks John Stepek.

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Stocks are not on the naughty list

Along with "sell in May", the "Santa Claus rally" is probably the best-known "seasonal anomaly" in investing. This is the idea that returns around Christmas time are better than average. And some evidence appears to bear it out. As Ian Cowie points out in The Sunday Times, in the 33 years since the FTSE 100 was established in 1984, the index has rallied in December no fewer than 27 times.

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The average monthly gain has also been impressive 2.5%, compared with 0.7% for the average month, according to figures from Adrian Lowcock at Architas. Similarly, notes John Heinzl in The Globe and Mail, from 1987 to 2016 December has also been the best month for the S&P 500, with 24 gains and just six losses, and an average gain of 1.85% versus 0.62% for other months. Similar patterns have been spotted in plenty of other places, from Canadian stocks to Germany's Dax.

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Is there anything to this? Defenders of the idea point to plausible reasons for its existence fund managers squaring up their portfolios at the end of the year, for tax or performance reasons (or both). But others argue that it's all in our heads. Heinzl, for example, runs the data past the University of Toronto's statistics department, which reckons the December effect can be explained away by chance.

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One problem is that sample sizes are too small. Thirty years sounds a long time, but it only gives 30 data points to analyse. So while the figures seem compelling at first glance 27 out of 33 certainly seems high the odds of it being a random effect remain high, which is something our pattern-seeking instincts prevent us from seeing clearly. As the mathematician Benoit Mandelbrot put it: "Human nature yearns to see order and hierarchy in the world. It will invent it where it cannot find it."

A more pertinent point is why would you invest on this basis? No one with any sense makes decisions about their long-term portfolio based on perceived seasonal fluctuations in the market the cost, risk and hassle involved is too high. Alternatively, if you are keen to experiment with your "fun" money or your trading pot, then there are more interesting and potentially profitable end-of-year trades out there.

Take, for example, the "Bounceback Strategy". As Stephen Eckett notes in the Investors Chronicle, this involves buying the ten worst-performing stocks in the FTSE 350 at the end of the year, then holding for three months. Since 2003, the strategy has beaten the market on 13 out of 15 occasions, with an average three-month return of 8.6% versus 2.9% for the index. Again, it could be entirely random but if you're going to take a punt on a seasonal anomaly, at least that sort of return seems worth having.

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