Stocks are down substantially this year, even including indices which had a bit of a rally through the last month or so. There has been a split in trend, which is worthy of note. The DJIA moved higher, while the Nasdaq remained relatively steady. In Europe, indices don’t concentrate in certain sectors like they do in the US, but a similar trend has emerged when considering certain types of firms.
The Dow Jones consists mostly of lower valuation, so called “value stocks”, which have been outperforming. Tech stocks have continued to underperform, even in periods of recovery. This is often attributed to their relatively high valuations, meaning that they are more speculative. The Fed’s tightening contributes to reducing interest in higher valuation stocks, and now the Fed is expected to slow its rate hikes. This could be an indication of which sectors/stocks could benefit the most from a Santa Rally.
What are the chances this time?
In order to make an educated guess about whether we can expect a rally this year or not, we need to have a better understanding of why it happens. Which is a bit of a problem, because there isn’t much agreement on the causes of the rally. Not only that, but there also isn’t even an agreement on when it happens. Some say it’s in the week before Christmans, others say it’s the week between Christmas and New Year, and still others say it’s both.
So far this month, stocks have been trending higher thanks to an expectation that the Fed won’t keep hiking rates so much. Now that they have delivered, the expectation is that US stocks can continue to rise. Across the Atlantic, the situation is a little more complicated, as the UK is expected to fall further into recession. Even if the BOE slowed the pace of hiking, there might not be as much room for optimism. Meanwhile, the ECB threatened to keep raising rates. That is expected, however, since the shared central bank was one of the last to join the hiking movement, so would likely be one of the last to end its tightening cycle.
What can we expect?
Santa rallies happen about 2 out of 3 years, on average gaining about 1.3% over the period from Christmas to the Jan 2 of the next year. It’s positive, sure, but not a blow-out growth. Particularly not in the context of the market losing around 17% since the start of the year.
Another difficulty is that the final two weeks of trading for the year see dwindling liquidity as major traders go on holiday. Usually, starting with the final meeting of the Fed, activity starts to drop off, reaching a minimum between Christmas and New Years. That means that volatility tends to increase, with more erratic moves in the markets as relatively small trades can cause bigger moves.
In general, markets tend to average higher through December. But in the case of the US in particular, they tend to do even better in an election year. 2018 was a notable exception, as the Fed was tightening though that period.
After stocks performed better in the run-up to the Fed, investors might have some time to digest the results. They could pay more attention to how the market is currently pricing in a terminal rate of 4.85%, but the average of forecasts from the Fed is 5.1%. That could lead to a revaluation of where the Fed could go in the first quarter of next year and let the Grinch into steak the Christmas cheer.