As the Yuletide season approaches, I want to express my view that Santa exists sometimes and this year is one of those times. The Santa Claus Rally is strong outperformance of equities particularly the best performers of the year through year-end. At the same time, there are many theories of why this happens or if it exists. I believe there are two real-world drivers. The first one generates buying flows, and the second limits selling. In years when the market has had strong performance funds that have underperformed are forced into the market and chase both the overall market and the best-performing stocks. This generates buying flows.
Since 1928 when stocks are up 10% by Nov 1 buying stocks that day generates an average return of 4.68% with a max return of 14% and a positive return 83% of the time. The max loss is 2.01% and when a loss occurs the average loss is 0.60%. 36 observations exist. Santa is real!
Secondly, as the year-end approaches, it makes little sense to crystallize a capital gain by selling the market or the best performers. Better to sell in January than sell in December. There is one exception that may be relevant this year but is unlikely to be relevant.
When capital gains taxes are increased it makes sense to realize a capital gain when the rate on that gain is lower vs holding and realizing the gain when rates are higher. The Dem’s Budget Plan includes an increase in capital gains taxes and could put coal in Xmas stockings. However when the budget was originally proposed the capital gain rate was retroactive. It would be fairly unlikely that a bill passed in 2021 would shift the rate increase to 2022. I could be wrong and will follow this closely as Santa doesn’t get going this early anyway. Nonetheless, performance chasing generating buying and delayed capital gain realization causing less selling have historically been powerful forces. I expect this year to be no different.