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As the days grow shorter and the lights on the stock markets shine ever brighter, talk often turns to the so-called “Christmas rally”. Yet behind the festive façade there is no heavenly blessing, but rather very earthly market mechanics – a combination of window dressing, thin liquidity and tax-driven selling. “For investors, this means treating year-end prices with caution – and enjoying the holidays to the full instead,” explains Thorsten Fischer, Managing Director and Head of Portfolio Management at Moventum AM.

The Christmas rally refers to a traditionally strong period in equity markets during the last five trading days of the old year and the first two of the new one. The term was coined by Yale Hirsch, who systematically analysed seasonal patterns in the Stock Trader’s Almanac in the 1970s. Hirsch found that between 1950 and 1971, the S&P 500 rose by an average of around 1.5 per cent during this seven-day period. Since the mid-1940s, gains have occurred in more than three-quarters of all years during this timeframe. The Christmas rally is therefore not merely a stock market fairy tale – but neither is it a guaranteed gift, as demonstrated in 2023/24, when prices “between the years” largely moved sideways.

Despite its contemplative name, the causes have little to do with festive cheer or bulging wallets. Neither optimism driven by Christmas spirit nor investments from year-end bonuses adequately explain the pattern. The notion that chronically optimistic private investors push prices higher in the absence of professional market participants is also difficult to substantiate.

Far more plausible are several structural effects that regularly occur at year end. One example is the window dressing carried out by fund managers: Many investment firms cosmetically enhance their portfolios at the end of a quarter or year. Underperforming stocks are sold, while winners are bought to present a stronger picture at the reporting date. This cosmetic effect generates additional demand for the year’s favourites – often observed among small caps or strong momentum stocks.

Another frequently underestimated Christmas effect is so-called tax-loss harvesting. Investors and funds sell poorly performing securities in order to offset losses and reduce their tax burden. “This intensifies selling pressure in particular on the year’s underperformers and on those stocks whose business models have recently failed to convince,” says Fischer. With the start of the new year, this selling pressure subsides, and many of these stocks experience a marked comeback – one that otherwise only athletes in motivational films seem to achieve: the classic January rebound.

Finally, there is the low liquidity and the prevalence of technical trading caused by the holiday season. Between Christmas and New Year, the market visibly thins out. “Fewer staff are sitting at the trading desks, hedge funds cut their risk exposure, trading volumes shrink – in this environment even small impulses have a stronger impact,” explains Fischer. Technical movements and heightened price volatility dominate, and these are not infrequently interpreted as a rally.

The prosaic truth, then, is that December’s magic rarely comes from the North Pole, but more often from tax law. The Christmas rally is less a market miracle than the result of seasonal market mechanics. Those who understand it can make targeted use of typical patterns. “At year end, prices should be viewed with healthy scepticism, while at the same time opportunities in oversold stocks should not be overlooked,” Fischer concludes.