The Santa Claus rally and money flows

Each year from roughly the end of the second week of December through the second week in January the stock market rises most of the time. This year, expect a similar occurrence.

There are plenty of explanations for why this occurs. Many believe it is simply the good cheer the holidays bring to the markets. Others point to the additional spending triggered by holiday shopping, while some argue it is because institutional investors buy stocks before going on their Christmas break. 

For me, it comes down to the flow of funds in and out of financial markets. Every year, for many reasons the flow of funds into the financial markets increases at the end and the beginning of each year, especially when the stock market delivers outsized gains like they have this year.

Think about it. Money managers saw gains of 20%-25% in 2024 in equity markets worldwide worth roughly $100 trillion or more. That means that there is now another $25 trillion-plus in gains that are available for investment.  Where does that money go?

Unless you and everyone else cash in all your chips and put them under your pillow, you would expect your investment advisor to reinvest that money into the stock market. If, as many believe, the future looks rosy, at least in the U.S., managers would like to put that money to work sooner rather than later.

But that is just the beginning. In December and January, the lion's share of bonuses are paid to employees worldwide. Most of that money will go straight into bank accounts, savings accounts, investment accounts, etc. That flow of funds will also find its way into financial markets.

Then, there are those contributions to all those tax-deferred accounts: (401)Ks, 403(B)s, IRAs—held by 50% of the American workforce. Much of these money flows hit the financial markets in the next month or so.

Many other pools of capital that are a bit more exotic also expire at the end of the year and begin again in January. These instruments like structured products, equity derivatives, yearly, long-dated options expirations, credit spreads and more have one thing in common—leverage. Every year, you take your winnings from last year, borrow money against them, and buy even more of whatever instrument you decide will make the most profits. This creates even greater flows of capital.

In a matter of weeks, this river of electronic capital flows into the financial system and washes up on the shores of various markets. A large portion will end up in the stock market. These flows should continue until the middle of January before ebbing once again.

This does not happen every year, but since 1950 December has been an up year 74% of the time as measured by the S&P 500 Index. That number climbs to 83% (in election years 100%) when the S&P 500 Index is up more than 10% in the first half. Many simply chalk the gains up to 'seasonality' without recognizing the powerful underlying currents that create this holiday phenomenon.

In any case, last week the S&P 500 tacked on another 50 points reaching the 6,100 level. Bitcoin finally passed the $100,000 mark before backsliding. And November's non-farm payrolls bounced back from a flood and strike-depressed performance in October.

This coming week all eyes will be on the last Consumer Price Index data before the Fed's December 18th meeting. I expect a hotter number which may (or may not) convince the Fed to pause before cutting interest rates again. I believe it won't matter in the broader context of money flows to a market that seems destined to continue to climb.

Bill Schmick is a founding partner of Onota Partners, Inc., in the Berkshires.  Bill’s forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners, Inc. (OPI).  None of his commentary is or should be considered investment advice.  Direct your inquiries to Bill at 1-413-347-2401 or e-mail him at billiams1948@gmail.com. Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal.