The Upcoming Midterms Might Ignite an Early Santa Claus Rally
Traditionally, the term "Santa Claus rally" refers to an upward move in the stock market that develops between Christmas and New Year's, but it could start earlier than usual in 2022
The stock market is anything but predictable, as seen in the rollercoaster observed in the markets since the onset of the COVID-19 pandemic.
But one phenomenon that’s been fairly reliable in recent years is the “Santa Claus rally.”
The term “Santa Claus rally” refers to an upward move in the stock market that typically develops between Christmas and New Year’s Day. From 1993 to the present, a Santa Claus rally has developed between Christmas and New Year’s Day on 20 of 29 occasions.
According to data compiled by the Stock Trader’s Almanac, Santa Claus rallies have averaged about +1.3% in the S&P 500 going back to 1950.
The fact that November and December have historically been good months for the stock market certainly doesn’t hurt this phenomenon. Since the inception of the S&P 500, the average returns in the S&P 500 for November and December have been 1.42% and 1.37%, respectively.
Considering those positive average returns, it shouldn’t come as much of a surprise to hear that market volatility tends to decline during the final quarter of the year. The graphic below highlights how volatility tends to peak in October, and then hit the lowest levels of the year, on average, during November and December.
While past returns are no guarantee for future performance, the aforementioned data provides important insight into the market’s average historical behavior. But there’s another important factor to consider in 2022—the midterm elections.
Market performance during midterm election years
Midterm elections in the U.S. are the general elections that are held near the midpoint of a president’s four-year term of office. Federal offices that are contested during the midterms include all 435 seats in the House of Representatives, and 33 or 34 of the 100 seats in the Senate.
Midterm elections are critical from a political standpoint because they serve as a referendum on the sitting President’s performance during the previous two years. The outcome of the midterms plays a key role in the future governance of the country, as well.
For the financial markets, the passing of the midterm elections is also important. Traditionally, the market tends to be more volatile during midterm election years, ostensibly due to uncertainty over the outcome of the elections.
However, historical trading data shows that volatility tends to decline substantially in the wake of the midterm elections. This is likely due to the fact that uncertainty stemming from the elections has been removed from the equation.
The fact that November and December are traditionally a couple of the lowest volatility months on the calendar probably doesn’t hurt either.
According to historical trading data, the stock market has performed better on average during midterm election years as compared to all other years—after the completion of the elections. The data also shows that the post-midterm rally can begin to develop a couple of weeks prior to election day, as illustrated in the graphic below.
Source: MarketWatch
The stock market historically rises during the last two months of the year, but this upward move has been more pronounced during midterm election years.
After an extremely tumultuous year in the financial markets, the passage of the midterms this year could therefore represent a welcome reprieve for bullish investors and traders. This year, the midterm elections are scheduled for Nov. 8.
The stock market has already staged an impressive rally since mid-October, and is up roughly 7% since Oct. 14. That performance closely mirrors the pattern observed during previous midterm election years, when rallies have emerged a couple of weeks ahead of election day.
To learn more about trading the midterm election cycle, watch this new installment of Market Measures on the tastytrade financial network.
For daily updates on everything moving the markets—including the midterm elections—check out TASTYTRADE LIVE—weekdays from 7 a.m. to 4 p.m. CDT.
Sage Anderson is a pseudonym. He’s an experienced trader of equity derivatives and has managed volatility-based portfolios as a former prop trading firm employee. He’s not an employee of Luckbox, tastytrade or any affiliated companies. Readers can direct questions about this blog or other trading-related subjects, to support@luckboxmagazine.com.
