Is the Santa Claus rally real?

As we approach Christmas, for yet another year, we wonder if Santa is real, or rather if the Santa Claus Rally is real.

Some hypotheses about the Santa Claus rally include the lowered Institutional liquidity as traders go on holiday (just like us, soon!). That leaves the retail crowd, proven to be bullish on just about anything, pushing markets higher. There have been many studies on this effect on the US markets with results ranging from slightly better than a coinflip chance to none at all.

We thought to experiment with this idea and look at the same effect but on another market instead.

With the massive benefit of hindsight, a simple, buy the Nikkei 225 in the middle of December and sell at the high/low before March comes around strategy, giving a win rate of 70% and an average win return of 10.3%, while the average loss was -11.3%. Interesting, but nothing much better than a coin toss with some variance.

Now as a Trader, we always try to position ourselves in highly expected value situations and find a unique edge where others might not look.

In this instance, how we can re-position ourselves is perhaps by looking at the spread between the US Index against the Japanese Index, before trying to identify the seasonal factor (Santa Claus Rally). But before we go further, it’s often good to think about how or why this trade might just work out:

1) Holiday impact – generally the Christmas holiday holds greater cultural importance in the US, hence it is likely that more will be on holiday in the US during this season.

2) Diverging monetary policies - The Bank of Japan remains one of the last central banks which stick to its negative interest rate policy (NIRP) even as inflation creeps higher. While the US Federal Reserve has led the world with its ultra-hawkish stance, raising its policy rates in a steadfast manner. The differences in monetary policies could nurture different directions for equities in respective markets, namely hawkish or tight conditions for the US vs dovish easing condition for the Japanese market.

3) Difference in accounting/Financial years – Differing accounting practices and book closure dates mean flows will differ for each market as institutional traders prepare to close their positions for their financial year.

4) Investors trying to front-run the January effect, where investors re-establish their positions after tax loss harvesting in December.

These factors combined drive the Japanese and US markets differently, especially over this, year-end, holiday season.

On to specifics, one way to look at the spread between the US and Japanese market could be to use the S&P500 Futures and Nikkei 225 Futures as proxy for the individual markets. Adjusting each Futures contract by the point value, $50 USD x S&P 500 Index point for the S&P500 Futures and $5 USD x Nikkei Stock Average for the Nikkei 225 Futures allows us to compare the two on a contract value/dollar for dollar basis.

Applying the same, buy in the middle of December and sell before March strategy, gives a similar 60% win rate, but the average win now returns 71.4% while the average loss is -18.3%. A very rough back of the napkin expected value calculation gives this strategy a rough 35% expected return while the strategy on the Nikkei 225 alone returns roughly 4%.

While one could try this strategy, we intend to provide a starting point to reflect on how we could creatively pair products to extract more value out of decades-old strategy. For example, on CME the listed Japanese Index Futures suite alone consists of products, such as the Dollar & Yen denominated Nikkei 225 (NIY/NKD) and Topix (TPY/TPD), all of which could be used to form variants of the above strategy. Something to think about as we head into the holiday season and prepare ourselves for an even better trading year ahead.

And just like that, we are on our last piece for the year. We will be taking the rest of the year off and back in January with more! Merry Christmas and Happy Holidays everyone!

The charts above were generated using CME’s Real-Time data available on TradingView. Inspirante Trading Solutions is subscribed to both TradingView Premium and CME Real-time Market Data which allows us to identify trading set-ups in real-time and express our market opinions. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs

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