November is typically the best month for stocks. A quirk among mutual funds may explain the weird phenomenon and point to big gains into year’s end

Central Park in the fall.rabbit75_ist/Getty Images

Talk of stock market seasonality tends to pick up towards the end of the year, and for good reason.

Since 1950, November has been the strongest month of the year for stock market performance.

A mutual fund quirk could be driving part of the year-end seasonality.

With November’s arrival, there’s a lot of talk on Wall Street about stock market seasonality towards the end of the year — and for good reason.

Since 1950, November is on average the strongest month of the year for stock market returns, and November through December is the strongest two-month period on average for returns, according to LPL Financial.

The consistent stock market strength in November comes shortly after September, which has historically been the worst month of the year for stocks.

These patterns have played out perfectly so far this year, with the S&P 500 falling 5% in September, and rising 4% in the first few days of November.

A number of theories have tried to explain the stock market’s seasonality. For example, bad Septembers have been attributed to cooler weather depressing sentiment among traders as well as the end of summer vacations on Wall Street driving increased selling.

For the year-end strength, one theory is that the spread of holiday cheer (and increased spending on gifts by consumers) encourages more buying than selling in stocks. This is often dubbed the “Santa Claus rally.”

But there’s one driver of stock rallies that is less anecdotal and has more concrete evidence to back it up: a quirk in the tax code for mutual funds.

Specifically, mutual funds have until October 31 to make their tax-loss harvesting trades for the year, three months before the deadline for retail investors. Tax-loss harvesting is a trading strategy to lower tax liability.

“Tax loss harvesting for institutional investors became increasingly prevalent after the Tax Reform Act of 1986, which mandated October 31 as the cut-off for most mutual funds to realize capital gains,” Bank of America’s Savita Subramanian explained in a note last year.

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