Toward the end of the year, U.S. stock markets tend to rise. Known as the Santa Claus rally, a stock market analyst in the early 1970s first coined the term after noticing a pattern of generally higher market returns between the first trading session after Christmas and the first two trading sessions of the new year. As such, investors have been conditioned to expect positive stock market returns during this period.
Since December 1936, stocks have returned an average of 2.3% in December and generated a positive return 79% of the time. Additionally, when stocks decline in November – as they did in 2021 – on average the S&P 500 rises 2.8% in December and closes with gains 88% of the time.
The Santa Claus rally that produced the best returns was at the end of 2008 and beginning of 2009 when a recovery from the financial crisis was getting underway. According to the Stock Trader’s Almanac, the S&P 500 rallied 7.4% in the six-day period between 2008 and 2009 – almost double the gains of the next strongest rally. The second-best rally came 10 years later at the end of 2018. These two rallies grew out of similar circumstances, as the 2008 rally came at the end of the worst year for the S&P 500 since the Great Depression, and the 2018 rally came at the end of the worst year for the S&P since 2008.
Despite all the positivity and favorable odds, that doesn't mean stocks are immune to a sell-off. Rising interest rates, supply chain issues, inflation, and worker shortages continue to be issues for many companies, which means they could be a drag on a year-end rally. However, Q4 earnings calls have also revealed that many companies have found ways to cope.
The S&P 500 plunged 7.6% in December 2018 due to a hawkish Fed and growth concerns. The current landscape seems eerily similar to 2018 and could derail any year-end rally in stocks. The Fed’s recent shift in stance, including accelerating the tapering of its monthly bond purchases, combined with near all-time highs in the market, sets the stage for investor caution. The worry is that the Fed is behind the curve and may have to hike rates aggressively, which could stall growth and the bull market. In a rising interest rate scenario, bonds underperform because bond prices and yields are negatively correlated and rising interest rates lead to a fall in bond prices. Rising rates may put pressure on the equity markets.
The November Consumer Price Index (CPI) reported consumer prices rose a blistering 0.8% from October of this year. More significantly, the nation’s annual inflation rate surged to 6.8%, a 39-year high dating back to 1982. In October, the inflation rate was reported at 6.2%, a 31-year high. For perspective, in January and February, inflation was reported at just 1.4% and 1.7%, respectively. Recently, Federal Reserve Chairman Jerome Powell officially dropped the term “transitory” to describe the current state of high consumer prices. Powell now admits that above-normal inflation will be with us through 2022. This may also put a crimp on a year-end rally.
And of course, the new Omicron variant of COVID-19 could exacerbate lingering supply shortages.
While past results are not indicative of future returns, history can tell us something, and investors shouldn’t lose faith about the potential for a Santa Claus rally. This phenomenon has happened 67% of the time over the past 27 years. It’ll be worth watching again as we continue on the road to economic recovery.
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