Back in 1972, Yale Hirsch did a huge favour for investment writers everywhere. In his research for the Stock Trader’s Almanac, he discovered the existence of the Santa Rally - and it’s been a indulgent source of Christmas-inspired stories ever since. Over several decades, the myth that markets generally rise through the second half of December has never gone away - and it’s not the only seasonal trend in the stock market that still lives on.
For those who believe that markets are efficient, the idea of seasonal trends - or anomalies - may seem like a fairytale. How can it be that shares persistently perform better in January, or on Fridays, or on the days before major holidays, or in late December? For that matter, why would shares generally perform comparatively badly in October, or on Mondays, or the days after major holidays? There are various possible reasons, but in general, nobody really knows.
How seasonal anomalies ruin efficient market theory
Take the January Effect. Distinct from the Santa Rally, the January Effect is a trend for stocks to outperform in the first month of the year. Research into this dates back to the 1940s. For example, one study of New York Stock Exchange data between 1904 and 1974 found that the average monthly return in each January in those years was 3.5%. The average return in the other months was 0.5%. That’s an eye-catching difference.
That particular piece of research was mentioned in an article by the behavioural finance theorist, Richard Thaler. Between 1987 and 1990, Thaler wrote a regular column called Anomalies in the Journal of Economic Perspective. They were masterful takedowns of ‘efficient market’ theory. He would set out research that very strongly suggested that human behaviour causes crazy price trends at times. This, he said, was completely at odds with the efficient markets hypothesis, which assumed there was an infinitely elastic supply of arbitrageurs and traders ready to buy or sell whenever prices vary from their intrinsic values.
In fact, in a follow-up article to his assessment of the January Effect, Thaler explored a host of other seasonal anomalies. Among them were weekend and holiday effects, and in each case he showed that share prices do see seasonal trends. He pointed to research finding that stocks go up more on Fridays than they do on Monday, and that pre-holiday periods are very strong for share prices.
