With the end of the year on the horizon, I thought taking a look at one of the most mentioned topics this time of the year would be relevant to readers. The Santa Claus Rally.

Before a few years ago, when a client asked about a potential rally before Christmas, I had assumed that the Santa Claus Rally took place leading up to Christmas. A quick Google search showed me that the more tangible rally that people refer to as brought upon by Jolly Ol’ Saint Nick actually takes place the week after Christmas until about January 2nd.

So let’s dig into a few numbers. In the past 20 years (2002-2021), the week leading up to Christmas has provided 13 positive return periods, 5 periods of negative return and 2 periods with little or no return. However, despite the nearly triple periods of positive return, the average return across all 20 years has been a meager 0.385%. The spread in these periods ranged from +5.4% in 2021 to -10.7% in 2018.

In contrast to that, the week following Christmas and into the New Year tells a slightly different story. Over the same 20-year period, there were 15 periods of positive returns, 4 periods of negative returns and 1 year of no return. The average return in this period year-end period is 0.715%, slightly skewed by the higher year-by-year returns in the 2001-10 period as opposed to the 2011-21 period.

As illustrated, the spread here is a tighter range, accounting for the higher average. So the Santa Claus rally, you could argue, actually takes place over the final 2 weeks of December and into the New Year, providing an average of 1.1% return to investors over those 2 weeks. Not bad, but hardly the rally that captures headlines on BNN and countless articles across the internet.

Now….beyond looking at the surface numbers of the Santa Claus Parade….here are a few tips to heed when considering your end of year trades

End of Year Tip #1

Make sure to have your trades in by December 28th this year as the trades must settle before the calendar turns over. Because of the T+2 settlement and the trading year Ending on Friday, December 30th, your trades must be in 2 days prior and cannot sneak a late minute trade in on the last trading day of the year. Those gains/losses will be settled in 2023 and won’t be able to be used until tax time in 2024.

End of Year Tip #2

If you’re selling a stock or two to capture gains and are worried about a quick rebound – consider replacing the stock you’re selling with a different, highly correlated stock.

Because you have to observe the “superficial loss” rules by not owning the same stock you just sold for 30 days in ANY account under your name, a corporate account in your name or a family member at the same address, you aren’t able to hedge your bets in case of a rally in the new year. However, what you can do is purchase a similar stock that has a high correlation to the stock you have just sold.

Stock correlation is a simple concept – some stocks move in very similar patterns to each other, called a correlation. A stock correlation of 1 means they move in perfect unison, a stock correlation of 0 means there is no discernible pattern in their movements and a correlation of -1 means the stocks move perfectly opposite to each other.

An example would be AAPL and MSFT. Both tech stocks, both highly susceptible to movements in the market. But are they correlated? Let’s use a really helpful website to check. Click the link below.

Stock Correlation Calculator

Using this website, you can input two stocks and a time period of your choosing to check the stocks’ correlation. The picture below will show you the result.

We can see here that AAPL and MSFT have a correlation of 0.9754 between Dec 2017 and Dec 2022. So if an investor in MSFT has taken a hit this year, they can feel quite confident in selling their MSFT shares and replacing them with AAPL, allowing them to capture the capital loss on MSFT, and hedging their bets on a rebound using a highly correlated stock. Be sure to understand that just because a stock was correlated in the past, does not mean it will be correlated in the future, especially in the very short-term period of 30 days.

End of Year Tip #3

Make sure you’re aware of any gains and losses between different currencies.

Using the example above, if an investor bought MSFT on the first trading day of the year, they would be down, as of this writing, over 26% on their investment. However, it isn’t as easy as simply taking that loss and moving on. The CAD/USD rate has weakened, as of this writing, 7.27%, meaning that your USD investment at the beginning of the year will actually yield more CAD when the trade settles, slightly lowering your capital loss in Canadian dollars. Be sure to account on a dollar-in vs dollar-out perspective as an investment of $10,000 down 26% will not simply net out to a $7,400 settlement after currency fluctuations.

End of Year Tip #4

Do not make in-kind contributions at year end. Always use Cash.

Many investors want to take capital losses and use the proceeds to fund either TFSAs or RRSPs. Doing so is a great strategy to realize losses and shelter future gains from tax. However, if you are making in-kind contributions to these accounts, the CRA will not recognize the loss on the non-registered side. The superficial loss rule will be enacted and your losses will be negated. So for example, a hypothetical investor, let’s call him Drew, happens to be down that 26% on MSFT referenced earlier. Drew, who is unfamiliar with the tax-loss harvesting rules, sees his capital loss position at year end and makes an in-kind transfer to his TFSA, looking to capture the loss in his non-registered account and own MSFT shares at a 26% discount in his TFSA. Because he never sold the shares and observed the 30-day trading window, Drew will not capture the losses and cannot use them against any future or pre-existing gains.

The inverse however, when dealing with capital gains, is different. If Drew were to have made an in-kind contribution using MSFT shares that happen to be +26%, his in-kind contribution would trigger capital gains for that year.

As discussed in tip #2, as an investor, you have two options. You can sell the MSFT shares, identify a correlated stock, such as AAPL and make the new purchase beforehand in the non-registered and then transfer the AAPL position in-kind OR make a cash transfer following the MSFT sale, and purchase you new correlated shares in the TFSA/RRSP.

Alternatively, you can sell the MSFT shares, transfer the proceeds to your RRSP/TFSA/etc and remain in Cash for the 30-day trading down and then re-purchase MSFT with the Cash in the registered account.

Regardless of how you choose to act, remember to make your sells beforehand, capture your gains or losses and use Cash to make any year-end contributions.

Have a great holiday season! Looking forward to chatting again come the New Year!

iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.