Labor Day Weekend: barbeques, beach days, last chance to wear white, and of course the celebration of the workers who built our country. Unless you’re heavily invested in a company that makes exclusively white shoes, you may assume that Labor Day won’t have much of an effect on your investments. But Labor Day is one of a group of holidays on which the stock markets are closed in the US. These long weekends produce a phenomenon known as the Holiday Effect.
What Is the Holiday Effect?
The Holiday Effect is a tendency for stock prices to climb right before holidays and long weekends. In fact, returns are often as much as 10 times higher on the day before a holiday as they are on a random day of the year. Not only is this phenomenon consistent from year to year, it’s also been recorded in stock markets all over the world.
Where Does It Come From?
We don’t really know what causes the Holiday Effect but there are a few popular explanations. Some companies, particularly in the retail sector, benefit from holidays like Christmas and Thanksgiving (Black Friday, actually). Their stocks rise during the holiday season, taking the stock market average with them. However, that doesn’t explain Labor Day and most other holidays. Some experts believe that it’s because traders have already checked out before long weekends, leaving lower market liquidity. Others suggest that short-sellers tend to end risky transactions before the long weekend. But the most popular theory is that investors are just looking forward to the holidays, making them feel and trade optimistically.
Which Holidays Count?
Of course, not every holiday causes the Holiday Effect (no blip for St. Patrick’s day). The US stock markets only close for nine holidays and these are the ones where you’ll see the Holiday Effect:
New Year’s Day
Martin Luther King Jr. Day
President’s Day
Good Friday
Memorial Day
Independence Day
Labor Day
Thanksgiving
Christmas
The stock markets also close early on July 3rd (in preparation for July 4th), the day after Thanksgiving (Black Friday), and Christmas Eve.
And That’s Not All
Of course, the Holiday Effect isn’t the only case when times and seasons seem to have a consistent effect on the stock market:
The September Effect – Studies have shown that September is the only month of the year whose average returns are actually below zero. September is known as the worst month on the market but nobody quite knows why. Analysts theorize that it has to do with traders come back from summer vacations and suddenly paying closer attention to bad financial news.
Monday Blues – Some believe that Mondays consistently show the week’s lowest stock prices. It could be because traders see bad news that came in over the weekend but many people suggest that it's actually just the influence of investors feeling cranky about coming back to work. Like with the Holiday Effect, the mood of investors influences the price of investments.
January Jump – In January, investors suddenly find that they have more capital to work with. That means that they’re more likely to buy and drive up prices. Over the course of the month, however, this shows up as erratic, volatile price movements, making January a dramatic month even if prices rise consistently.
Quarterly Rebalancing – At the end of each quarter, large investors (like big institutions) reassess their portfolios. This causes volatility in the market as large volumes of shares are bought and sold.
Why Does It Matter?
Now that you know about the Holiday Effect, are you worried you missed an opportunity now that Labor Day is gone? Thanksgiving is right around the corner and after that comes Christmas. On the other hand, there are a whole lot of Mondays and the end of a quarter between now and then. And none of these have anything to do with the actual value of companies or the state of the economy.
Understanding these kinds of phenomena can help us understand why stable investing involves holding a portfolio over time. If you do that with a diverse portfolio, you can safely ignore the Holiday Effect. Don’t worry – you didn’t miss out.