Will December deliver some much needed seasonal cheer to investors with a 'Santa Rally'?

With the imminent arrival of December,  many people will be scaling back on their Christmas spending this year given the cost-of-living crisis and economic woes. It has also been a gruelling year for investors, with both stock and bond markets tumbling as inflation has soared to the highest levels in forty years and interest rates have risen sharply.

As the year draws to a close, investors could certainly do with some seasonal cheer. Could the month of December offer up a financial Christmas present? Potentially if history is anything to go by. That’s because December has earned a reputation as a typically strong month for stock markets - a phenomenon dubbed as the ‘Santa Rally’.

Bestinvest has once again put this theory to the test, analysing 50 years of data for monthly returns on both global and UK equity markets (using the MSCI World and MSCI United Kingdom indices on a total return basis in Sterling).

Far from being a myth, we found compelling evidence to support the idea of a ‘Santa Rally’. Looking at 50 years of monthly market data for global equities, December has the highest incidence of any month in providing investors with positive returns, with shares making gains 76% of the time, a far higher proportion than any other month.

Looking at the MSCI World Index, which is comprised of more than 1,500 of the world’s largest listed companies, we found average monthly total returns over the last half century ranged from as low as -0.31% in the often dangerous  month of September to as high as 1.71% in January. Not only has December proven to be the most consistent month for delivering positive global equity gains, an average total return of 1.45% for the festive month is also high compared to the average monthly return for global equities across all months over the last half century of 0.95%.  Particularly impressive Santa Rallies were seen in 2010 (6.8%), in 2008 in the aftermath of the global financial crisis (10.2%) and in 1999 at the height of the Dot Com Bubble (6.8%).

And when it comes to the UK stock market, using the MSCI United Kingdom Index of large, London Stock Exchange listed UK companies, the high success rate for December was also evident, with the month also delivering positive total returns 76% of the time and with an average monthly gain of 2.26% over the 50 years. However, unlike the global snapshot, in the UK April had the highest incidence of gains overall, delivering positive returns 82% of the time.

In contrast, Bestinvest’s analysis has identified June as the most dangerous month on average for stock markets, both globally and in the UK.

What’s the theory behind the ‘Santa Rally’?

There are various theories about seasonal trends in stock markets including the old saying that investors should ‘sell in May’ and return after the summer, but it does seem that the Santa Rally is one of the most convincing.

Explanations as to why stock markets tend to do well in December include the markets getting a boost as City fund managers position for the year ahead, investing any spare cash in their funds to ‘window dress’ their portfolios ahead of reporting periods.

Another is that hedge funds who take negative bets on companies – known as ‘short positions’ - close out some of these positions before the year end. This would require them to repurchase shares that they have borrowed off other investors in order to sell them and then hopefully repurchase them at a lower price later, before returning the shares to the stock lender.

Of course, it could just be a case of seasonal cheer and the magic of the festive season!

While December is often a strong month for the equity markets, there is no guarantee this will be repeated this year and it is important to invest with a long-term horizon in mind.

What is undeniable is that share valuations have deflated considerably over the last 12-months as markets have adjusted to a tougher outlook for the global economy. In the UK, valuations of the large companies of the FTSE 100 are incredibly cheap compared to longer-term trends, trading at prices that represents 9.5 times their project profits for the next year. The longer term average is just over 12 times and so this does represent a very considerable discount.

While it rarely seems like it at the time, investing when the news is gloomy, times are tougher and markets are sharply down, can often prove to be a good entry point for long-term investors. For those who are unsure about whether it is a good time to invest, a sensible way to proceed is to gradually feed money in on a regular basis in bite-sized chunks, as this helps iron out the effects of short-term volatility.