Will Fed Grinches steal Santa Claus rally?

Does the "Santa Claus Rally" really exist? Some market pundits have noted that the seven-day period from Christmas through Jan. 3 has unusually high returns in the stock market. Srinivas Nippani of Texas A&M University-Commerce, Ken Washer from Creighton University and I studied the Santa Claus rally around the globe.

What we found is that the Santa Claus rally is indeed present in both Christian-based countries and non-Christian based countries around the globe. Specifically, returns are higher for that seven-day period than the average of other seven-day periods during the year. This is not a U.S.-based phenomenon; the consistency across the globe is startling. The returns over the Santa Claus rally period are greater than returns in the non-Santa Claus rally period for all 16 countries that we studied: U.S., Canada, Mexico, Brazil, UK, Germany, France, Australia/NZ, Japan, Hong Kong, China, Singapore, India, Indonesia, Taiwan and South Korea.

How the Grinch Stole Christmas
Source: Warner Bors. Entertainment Inc.

The magnitude of the Santa Claus rally is not inconsequential. For the U.S. S&P 500, since 1950, the return advantage over the holiday period versus the non-holiday period is about 17 basis points per day (0.17 percent). After transactions costs, a $10,000 investment in the S&P 500 would have generated about a $100 profit advantage over the non-holiday period on average.

The consistency is illustrated by the fact that, since 1950, the percentage of positive days during the Santa Claus rally period for the S&P 500 was 62.3 percent. For context, the percentage of positive days for the entire year since 1950 was only 52.9 percent.

The research also shows that the Santa Claus rally period exhibits less risk, as there is a lower standard deviation of returns during that period. In addition, there are more extreme returns that are "good" and fewer extreme returns that are "bad." And, as we know in investments, higher return and lower risk is "The Holy Grail."

This year's holiday period comes at a very interesting time, as the Fed just hiked the federal-funds rate for the first time in nearly a decade, and that generally is bad news for the equity markets. In research for "Invest With the Fed," my co-authors and I found that equity-market returns were dramatically higher when interest rates were falling than when rates were rising. From 1966 through 2013, the S&P 500 returned 15.2 percent when rates were falling and only 5.9 percent when rates were rising.

Bottom line for investors is that the holiday season is generally a great time to be invested in the stock market. While we couldn't find hard evidence that Santa Claus actually climbs down the chimney and brings gifts to children, we did find that the Santa Claus rally is real and generally delivers handsome returns to investors. The big concern this year is that Janet Yellen could be the Grinch who steals the Santa Claus rally from investors.

Longer term, investors should consider moving into industries that have historically performed well in an environment characterized by rising interest rates, as almost all agree that the Fed will likely raise rates several times in 2016. We found that defensive sectors – consumer goods, food, utilities and energy have historically performed better when the Fed was pursuing a restrictive monetary policy. People need to eat, brush their teeth, put gas in their cars, and heat their homes whether the economy is strong or weak and irrespective of Federal Reserve monetary policy.

Commentary by Robert R. Johnson, president and CEO of The American College of Financial Services, a non-profit, accredited, degree-granting institution in Bryn Mawr, Pa. He is also co-author of "Invest with the Fed" (2015). Follow him on Twitter @BobAmericanColl.