Traditional Santa Stock-Market Rally Likely Ahead, With a Few Caveats

(Bloomberg) -- All signs point to a traditional ‘Santa Rally’ in the U.S. stock market next week, but this year’s comes with a few caveats. 

Some investors are questioning if the stock market is due for a repeat of 2018, given anticipation of as many as three rate hikes in 2022. Yet, historically, the trend remains upbeat over the last 10 years, with a 0.7% average return for the S&P 500 during the last week of December. And any repeat of the 2018 panic would likely be preceded by elevated volatility, something that the VIX curve has yet to flag.

It all tends to build up to an increase in volatility going into January, with the S&P 500 only having posted positive returns for the month five out of the last 10 years. Add on Congress returning to session January 3, with reviving the Build Back Better plan at the top of the agenda, and equity investors could see a rocky start to the new year. That’s especially likely to be the case as they reallocate and perhaps pare back the gains on the portfolio from the market’s holiday cruise control mode. 

The last factor to address is liquidity, the ability to easily turn an asset to cash. Traditionally thin during the holiday season, with the exception of the last two years thanks to first the onset of Covid, and then vaccine news, stock market liquidity still remains higher than its October levels. For now, that’s a good thing because it means the market moves per dollar traded this week are relatively smaller, but going into next week, that impact could grow as liquidity returns to its longer-term historical norm. 

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