Wall St Week Ahead - Stocks typically rally in December, investors have some caution this year

Investors hoping for the year-end to bring stock market gains after a punishing year have history on their side as US equities traditionally rally during the month of December, but many remain sceptical of forecasting a rise.

The S&P 500 has gained an average of 1.6 per cent during December, the highest average of any month and more than double the 0.7 per cent gain of all months, according to data from investment research firm CFRA. September, meanwhile, is the worst month of average for stocks, with a 0.7 per cent average decline.

Gains would be welcomed by many investors after seeing the S&P 500 Index fall around 16 per cent so far this year. Still, weighing on the market has been the US Federal Reserve’s actions to aggressively tighten interest rates to fight inflation.

“December is usually a good time for investors but right now they are stuck because it’s really the focus on rates that will cause the market to go up or down in the short term,” said Sam Stovall, chief investment strategist at CFRA Research.

“The question this year is will the Fed raise by 75 or 50 basis points, and whether there will be any dovish commentary that suggests that the Fed will raise rates one or two more times next year and then call it quits,” Stovall said.

December is typically a good month as fund managers buy stocks that have outperformed over the year for so-called “window dressing” of their portfolios while there are year-end inflows and lower liquidity during holiday-shortened weeks, said Stovall.

At the same time, US stocks have risen during the last five trading days of December and the first two days of January 75 per cent of the time since 1945, according to CFRA, in a so-called Santa Claus Rally. This year, the time period starts on December 27. The average Santa rally has boosted the S&P 500 by 1.3 per cent since 1969, according to the Stock Trader’s Almanac.

This year, however, investors’ focus has largely shifted to the Fed and the pace at which it will continue raising interest rates as it attempts to bring inflation down from near 40-year highs.

“Investors tend to be optimistic going into the new year but this is still the Fed’s market,” said Brian Jacobsen, senior investment strategist at Allspring Global Investments. “The old saying is that ‘the trend is your friend and don’t fight the Fed,’ but now it’s ‘the Fed isn’t your friend, so don’t fight the trend.’”

Investors are pricing in a 75 per cent chance that the Fed will raise rates at its December 14 meeting by 50 basis points to a target rate of 4.5 per cent, while the probability of another jumbo 75 basis point move is at 24 per cent according to CME’s FedWatch tool.

Minutes released on Wednesday from the Fed’s November 2 meeting showed that a “substantial majority” of policymakers agreed it would “likely soon be appropriate” to slow the pace of interest rate hikes,” though Fed members believe that there is “significant uncertainty about the ultimate level” of how how rates need to rise.

“Things look pretty decent if you have a one-year time horizon, but not without some potentially significant volatility in the next quarter or two,” she said.