End of Year Stock Market Rally and Effect: A Seasonal Myth or Reality? (Backtest Analysis)

As the year is drawing to a close, you might have heard about an end-of-year stock market rally. Is this seasonality true, fiction, or myth?

The end of year rally is no myth or fiction: research shows that stocks tend to rally and go up at the end of the year. 

We already know that the stock market is very strong in the period from October until the end of April next year. However, let’s backtest to find out if there is a specific end of year stock market rally during the last days of the year. 

Related reading: Seasonal trading strategies

End of year stock market rally – trading rules

Let’s backtest the following trading rules:

Trading Rules

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We backtest the cash index from 1970 until today and get the following equity curve:

End of year stock market rally
End of year stock market rally

The performance is pretty consistent with a win rate of 68%. The average gain is 1% and the average winner is significantly bigger than the average loser. 

The holding period is a maximum of ten trading days, and the shortest is 6 days. 

Why is there an end of year stock market rally? 

We have established that the year-end stock market rally is a phenomenon that occurs in the final days of the year, with stock prices rising as investors become more optimistic about the upcoming year, or that the lack of news simply makes the stock market rise because of a “news vacuum.”

However, let’s look at some potential causes for the rally and effect:

  • Seasonal factors: Historical data shows that stocks tend to perform well in the fourth quarter, with the average return for the S&P 500 index being around 4.1% since 1970 for the cash index (not including reinvested dividends). 
  • Investor sentiment: As the year draws to a close, investors might often become more optimistic about the upcoming year, as they believe that any potential economic problems will be resolved. This optimism can lead to a wave of buying as investors seek to buy stocks before the end of the year.
  • News vacuum: As the year draws to a close, there is less news to focus on. 
  • Monetary policy: Research shows that the Federal Reserve (Fed) often begins to ease its monetary policy in the fourth quarter, which can lead to lower interest rates. This can make stocks more attractive to investors, as they become cheaper to borrow. Lower rates make stock comparatively more attractive.

This might be some of the reasons for the year-end stock market rally. That said, as quantitative traders we are not interested in causes, but in exploiting them.

End of year gold market rally – trading rules

At the end of the article, we would also like to mention that there is an end of year rally in the gold price.  

We use the same trading rules as for the stock market and we get the following equity curve since 1980 for the gold price:

End of Year rally for the gold price
End of Year rally for the gold price

The average gain is 1% with a 65% win rate. 

FAQ:

What are the specific trading rules for the end-of-year stock market rally?

The trading rules involve buying the S&P 500 on the third Friday of December and selling at the close on the last trading day of the year. The backtesting results show consistent performance with a win rate of 68%, an average gain of 1%, and a favorable risk-reward ratio.

Why does the end-of-year stock market rally occur?

The rally may be influenced by seasonal factors, historical data indicating strong performance in the fourth quarter, increased investor optimism about the upcoming year, a potential news vacuum as the year concludes, and the Federal Reserve’s tendency to ease monetary policy in the fourth quarter.

What are the trading rules for the end-of-year gold market rally?

Similar to the stock market, the trading rules involve buying gold on the third Friday of December and selling at the close on the last trading day of the year. The backtesting results demonstrate positive performance for this strategy. The end-of-year gold market rally, based on backtesting results, shows a 1% average gain with a 65% win rate. While the specifics may differ, both stock and gold markets exhibit positive performance towards the end of the year.

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