The Santa Claus stock market rally could stumble this year as Fed hawkishness and rich valuations scare investors, Bank of America says

NYSE in December
  • December has been the strongest month of the year for stock returns based on historical data.
  • But the Santa rally may be derailed this year as fears of the Omicron virus hit markets.
  • “We remain cautious on the S&P 500 in the midst of a hawkish Fed tightening to an overvalued market,” Bank of America said Thursday.

Investors have been conditioned to expect positive stock market returns in December, as it is seasonally the strongest month of the year, according to data from Bank of America.

The movement higher is often called the Santa Claus rally because stocks have yielded an average of 2.3% in December since 1936 and generated a positive return 79% of the time.

Despite these favorable odds, it does not mean that equities are immune to a significant divestiture, as was seen in December 2018, when the S&P 500 dipped 7.6% due to a hawkish Fed and growth concerns.

Now the similar concerns are resurfacing this year and they could derail any rally by the end of the year in equities, Bank of America Savita Subramanian said in a note Thursday.

“Any resurgence of COVID could exacerbate persistent supply shortages,” Subramanian said, acknowledging that more information is needed to assess the lethality and transmissibility of the Omicron variant.

Another risk that could slow growth is “an inflation-driven consumption hit, especially as fiscal and monetary stimulus runs out,” the memo adds.

On November 30, Fed Chairman Jerome Powell told Congress that an acceleration in the downsizing of its monthly bond purchases could be justified, even in light of a new coronavirus strain. The comments signal that Powell is now more focused on curbing inflation than reducing unemployment, according to Subramanian.

The Fed’s change in stance, combined with rich stock market valuations, could create problems for investors. “We remain cautious on the S&P 500 in the midst of a hawkish Fed tightening to an overvalued market,” Subramanian warned.

But according to LPL’s Ryan Detrick, investors should not lose faith in the potential for a Santa rally if the next two weeks are uneven for the stock market.

“December may be strong for equities, but keep in mind that it’s the second half of the month that Santa Claus usually shows up,” Detrick said Wednesday.

The S&P 500 returns in December

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