A Santa Claus rally in US stocks was expected by investors as inflation started to cool down. However, the Fed’s response in tackling inflation through more rate hikes albeit of lesser magnitude is keeping markets confused. The rally seems to have taken a pause for now. There are valid arguments for pausing, regardless of whether the rally is over. The Fed meeting the following week is approaching, and a significant CPI announcement will occur soon before it.
The stock market outlook for 2023 is not as rosy as was expected earlier. Before the year-end, the volatility is anticipated to remain high. Longer-than-expected rate hikes from the US Fed, their impact on the economy, and corporates’ margins and earnings are still to be evaluated by investors. “The Santa Claus rally is cancelled this year as the equity market navigates higher yields and contracting earnings. Seasonal tailwinds that have traditionally driven Santa Claus rallies pale in comparison to the plethora of headwinds the equity market currently faces,” says José Torres, Senior Economist at Interactive Brokers.
“Taken together with higher yields, contracting earnings, geopolitical uncertainty and increased risks of more liquidity surprises, such as bankruptcies, restructurings, crypto blunders, etc., the S&P 500 is too expensive at 18 times peak earnings,” adds Torres.
The year 2022 has not been kind to investors thus far, with the S&P 500 falling by almost 17% and the tech-heavy Nasdaq 100 falling by nearly 29% year to date. Dow 30 is down by 7% in 2022 YTD but over the last three months has bounced by nearly 7%.
Post-rate hike commentary by Fed chief Powell on December 14 will be crucial as it comes in the backdrop of December 13 US CPI data for November. A sharp decline in expectations of the Fed tightening may open the door for an end-of-year equity market surge else the bears may become more active. Torres is of the view that further downside is likely in December as market investors front-run an earnings recession anticipated for the first quarter of 2023.