Will a Santa rally brighten markets at year end?

As the year draws to a close, investors are watching to see whether the so-called Santa rally will once again deliver a seasonal lift to equity markets.

The term refers to the tendency for shares to rise in the period spanning the first trading session after Christmas and the second session of the New Year, a window that has traditionally been associated with modest but consistent gains.

December has historically been the strongest month for the FTSE 100 (^FTSE), but a buoyant end to the year has proved a poor guide to what comes next.

Since the index was launched in 1984, December has delivered the highest average monthly return, rising by 2.1% on average. Only April and July have produced average gains of 1% or more over the same period. The pattern has helped entrench the idea of a so-called Santa Rally, even if its causes remain uncertain.

“In his novel Pudd’nhead Wilson the American writer Mark Twain cautioned about October, saying: ‘This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.’ Yet even he might have to admit to December’s festive charms, as it is easily the best-performing month over time,” said Russ Mould, AJ Bell investment director.

“Since its launch in 1984, the FTSE 100 index has gained 2.1% on average in December, whereas April and July are the only other months to offer an average advance of 1% or more.

“If you want to know why markets talk about the Santa Rally, that is why — because the numbers back it up. Quite why the Santa Rally should occur is less clear.”

The idea that January offers a fresh start for markets has weakened over time. “Investors used to talk about ‘the January effect,’ as money managers put clients’ money to work and into the market in the new year, but since 2000 the FTSE 100 has only advanced 10 times in 25 attempts in January and has chalked up 15 losses, so that may be the end of that,” Mould said.

He suggested that investors may have pulled forward those flows. “It is possible that the Santa Rally has developed because investors have looked to anticipate the January effect, and price it in or discount it.”

Even so, a strong December has rarely been a reliable signal for the year ahead. The FTSE 100 has fallen just nine times in December since 1984, and only six times since 2000. Yet of the 11 years in which the index has posted an annual decline, 10 were preceded by a December gain. The sole exception was 2015, when a 4.9% fall over the year followed a 2.3% decline in December 2014.