Santa arrives - right on schedule for a market rally

Here at Investor Clinic, we're skeptical of axioms that purport to hold the secret to achieving great wealth in the stock market. We don't "sell in May and go away," for example. Nor do we time our buys and sells with the U.S. presidential election cycle.

Being fans of the buy-and-hold approach, we prefer to invest - and stay invested - in companies that increase their earnings and dividends. The problem with trying to time the market isn't only that you might guess wrong; you'll also face higher commissions and taxes.

But there is one seasonal pattern that intrigues us enough to dig a little deeper. We refer to the stock market's exceptionally strong performance in the month of December.

Is it just chance that the market almost always rises as the Christmas decorations are going up? Is it an excess of rum and eggnog? Should investors try to take advantage of this trend?

Before we try to answer these questions, let's look at the numbers.

In the past 25 Decembers, Canada's benchmark stock index has risen 23 times and fallen just two, including a 3-per-cent drop during last year's financial maelstrom. The only other losing December over that period was in 1996, when the index slipped 1.5 per cent.

The average gain in December over the last quarter-century was 2.37 per cent, which is more than three times higher than the roughly 0.7-per-cent average advance for all months. With yesterday's 260-point or 2.27-per-cent rise on the S&P/TSX composite index, this December is off to a flying start.

Sure, it could be random luck - but not likely. A few years ago, Thomson Financial crunched the December returns from 1969 through 2005 and found a 99-per-cent probability that something other than chance was behind the outsized gains.

So what factors might explain December's jolly performance?

Well, for starters, there's investor emotion. When the holidays are approaching, people are in a cheerful mood, and that optimism colours their perception of the market. December is also when year-end bonuses get handed out on Bay Street, and some of that cash may be plowed into stocks.

Tax-loss selling may be another factor. In the fall, investors sell their dogs to trigger capital losses for tax purposes, pushing the market down in October and November. But that downdraft attracts bargain hunters who lift prices back up in December, or so the theory goes.

Window-dressing may also come into play. Eager to make their books look pretty for year-end statements, fund managers buy winning stocks as the year draws to a close, giving prices a boost.

A final theory is that the Santa Claus rally is a self-fulfilling prophecy. Because everyone anticipates that the market will rise in December, they buy stocks, and sure enough, that's what happens.

So if December is such a great month, should investors place a big wager on the market on Nov. 30 and sell on Dec. 31, aiming to pocket a quick profit? Unfortunately, it's not that simple.

Although December has produced remarkably good results, on average, there is a lot of variability in the monthly returns, ranging from last year's 3-per-cent slide to an 11.8-per-cent gain during the tech mania of 1999. There have also been several Decembers when the market rose less than 1 per cent, which would barely cover the costs associated with buying and selling an index ETF (depending on the size of the trade and the commissions charged).

It's also important to remember that the December data are backward-looking. Whatever the cause of December's strong performance - it may be one factor, two factors, or a whole bunch of things - it's impossible to know whether the future will look like the past.

"The statistics prove December is a fairly reliable month for good performance in the market, and I can't dispute it," says Tim Burt, CEO of Cardinal Capital Management in Winnipeg. He predicts this December will continue that trend, as the end of the recession and improving corporate earnings give stocks a boost.

But he doesn't advocate trying to get in and out for a quick buck.

"That's a speculative trading strategy. We would never recommend people do that," he says. "We're buy-and-hold, long-term investors. So really what happens month to month is immaterial to us."

The nice thing about being a buy-and-hold investor is that you'll never miss out on big gains - whether they come in December or any other month. So instead of trying to time the market's ups and downs, just sit back and enjoy Santa Claus's generosity.