Have you been watching the markets lately? If you are getting into investing then you should be keeping up with how the stock market is doing each day or at least week to week. For those of us that are buy and hold investors, checking in on the market’s performance on a month to month basis is usually good enough. However, you should be informed of big economic movements like what is happening in Europe right now with Greece and the PIGS. But the markets are not always doom and gloom. There are some events that happen on a year to year basis that could benefit you.
The Santa Claus Rally
The Santa Claus Rally is one of those events that is expected to happen year to year. It is called the Santa Claus Rally because it occurs right around Christmastime and goes through the end of the year. Each December the markets are usually uplifted and show positive performance. If you’re a superstitious person, then you might believe it’s because Santa Claus is really bringing a gift of cash to your portfolio but there are a few reasons I believe it happens and they are a bit more rational.
Mutual fund managers work hard to generate a steady return each year based on their chosen style. If they are a large cap manager they will only invest in stocks with a large market capitalization. Mutual funds are regulated and part of that regulation involves a restriction on short selling. Before the end of the year, a mutual fund manager may have a portion of cash on the books. Some of that comes from the constant percentage of cash that they decide to have on hand but there is usually a higher amount of cash on hand from stocks that pay capital gains at the end of the year. The mutual fund will payout or reinvest. With a higher chance that they will reinvest, mutual funds are buying into the market and thus the overall price goes up.
Hedge funds are a little bit different from mutual funds in that they are allowed to short sell as well as go long. Hedge funds are usually highly leveraged; for example, for each dollar of cash they may have 10 dollars invested. They use margin and other methods of borrowing to generate outsized returns for their investors. Before the end of the year, many hedge funds are looking to close short positions and invest excess cash similar to mutual funds. All of this closing short positions increases normal buying activity. This coupled with buying to get excess cash off the books pushes the markets higher.
Tax Time Benefits
The last practical reason that I see the markets rallying into the new year has to do with tax benefits. If you experienced a loss in one stock or several and you don’t plan on keeping that stock in your portfolio long term, you may consider selling it to take advantage of the ability to claim the losses on your next year’s tax return. However, if you are smart, you won’t just take the cash and run, but you will invest the cash back into the markets. Some investors are also buying stock as a gift for relatives before the end of the year to take advantage of tax benefits from gifting. The tax code rules and benefits have a heavy impact on end of year selling and buying and play a part in the Santa Claus Rally.
The Santa Claus Rally normally extends from after the American Thanksgiving holiday into the New Year. This year provided a really nice opportunity to buy into the dip in November and get ready for the rally.
Did you position your portfolio for the Christmas gift from Santa Claus?
This post was written by Latisha.
Disclaimer: Although this rally is well known in the investment industry, it is not always guaranteed and you should always consult your financial advisor before beginning any investing strategy to determine the suitability of the strategy.