End of the year rally? A bullish stock market pattern is set to collide with stagflation fears

The period between now and the end of the year marks a historic bullish final stretch of the year for US stocks, especially just before and after Christmas. The question for investors is whether the favorable seasonal factors will be outweighed by economic fundamentals.

Momentum for a year-end rally in stocks seems to be getting stronger now that the S&P 500 SPX,
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It rose 12.6% from its lowest level in October – buoyed by better-than-expected inflation reports for the past month and the business-friendly Republicans narrowly winning the House of Representatives.

DJIA Dow Industries, Inc.
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It has jumped nearly 20% since its late September low, on the cusp of a threshold that would mark an exit from a bear market, while the Nasdaq Composite put up a mediocre performance as investors remain in a wait-and-see mode over the Fed’s December rate decision. , and more inflation data, geopolitical risks abroad.

Major indices posted gains in a shortened Thanksgiving week, with the Dow Jones up 1.8%, the S&P 500 up 1.5% and the Nasdaq Composite advancing 0.7%.

Then there are seasonal tailwinds towards the end of the year. According to market data from Dow Jones, the S&P 500 rose 71% in the period from Thanksgiving to the end of the year, based on numbers going back to 1950. On average, the large-cap index rose 1.8% in that period. This data can be a rough guide for investors, but it does not guarantee performance in a given year, as the red lines in the chart below show.

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        Dow Jones market data
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   This favorable seasonal pattern could clash with fears that 2023 could bring stagflation: the worst possible economic outcome for which investors will be hard-pressed to prepare.  Stagflation is defined as a period of slow economic growth plus persistently high inflation, a dynamic that may already be underway in the United States </p> <p>Warnings of a possible deep recession in the US flash regularly in the bond market, with the spread widely followed between -2 TMUBMUSD02Y,
    <bg-quote field="percentchange" format="0,000.000%" channel="" class="">4.508%</bg-quote>
   and the 10-year Treasury yield TMUBMUSD10Y,
    <bg-quote field="percentchange" format="0,000.000%" channel="" class="">3.700%</bg-quote>
   It's still near -80 basis points -- which means the 10-year rate stands roughly 0.8 percentage point below the two-year yield.  Last week the curve reached its sharpest inversion since 1981. Such inversions are a reliable indicator of recession. </p> <p>US growth turned positive in the third quarter and inflation appears to be moderating, based on the Consumer Price Index for October, with the annualized general rate falling to 7.7% from 8.2% previously.  However, price gains are not coming fast enough for the Federal Reserve to completely abandon sharp interest rate increases, which could send the world's largest economy into contraction.

“The hard part for investors in a stagflationary scenario will be the confusion about where to invest,” said Mark Neumann, founder of Atlanta-based Constrained Capital and founder of the ESG Orphans Index, which tracks stocks with a combined market capitalization of $3 trillion.

This is a reversal of the market trends that have prevailed for most of this year and is “due in part to investors being extreme in these trades being tipped by a fear of missing out.” [on] “Year-end rebound,” said Jason Drahue, head of asset allocation for the Americas at UBS Global Wealth Management.

Adding to last month’s bullish tone in equities, stronger-than-expected October retail sales as well as a weaker-than-expected producer price report, both of which show that “the economy is holding up well, despite a sustained rally in short,” said Sam Stovall, chief investment strategist at Investments. CFRA Research in New York, “Term Duration Averages.”

“Seasonality will provide a little bit of a support for equities at the end of the year, and I think investors are expecting the Fed to rise 50 basis points in December and maybe not be all that hawkish in their statement,” Stovall said via Cross. phone. “Right now, the stock market is assuming we don’t fall into a recession or, if we do, it will moderate and the Fed will likely cut rates in the latter part of 2023.”

He said the CFRA’s economic outlook calls for the US economy to narrowly ride out recession, yet still fall into stagflation, followed by a U-shaped recovery, rather than a V-shaped recovery.

“If the inflation trend continues to go downward — that is, inflation drops gradually but consistently — that would be enough to make investors complacent, in my view,” Stovall told MarketWatch. “Additionally, we expect to see improved corporate earnings growth as we move into 2023.”

According to Stephen Suttemeyer, chief technical equities strategist at BofA Securities, the last 10 trading sessions of December through the first 10 of January have proven to be a bullish period for the S&P 500, time and time again: the index is up 72% in that time with an average return of 1.19% during the last 10 trading sessions in December, he said. That strength tends to carry over into the new year, as the S&P 500 is up 64% of the time with an average return of 0.72% through the first 10 days of January.

Mark Hulbert: It’s probably going to be “Santa Claus going up” for stocks this year — but you won’t be opening presents until after Christmas

These year-end seasonal factors go hand in hand with a well-known pattern that has seen stocks perform their best over a six-month period beginning in November.

The six-month period from November to April tends to particularly favor stocks across the range of cyclical stocks, according to strategist Rob Anderson and analyst Thanh Nguyen at Ned Davis Research. The NDR’s Broad Cyclical Index, which includes the industrial, consumer appreciation and materials sectors, has outperformed a defensive basket made up of commodities, health care, utilities and telecoms, on average, among those six months since 1972.

They also said that technical reasons support the case for a year-end rally in US stocks, while noting that “external forces can overwhelm seasonal trends.”

Source: Ned Davis Research

Highlights for the week ahead include Thursday’s release of the Fed’s preferred inflation measure for October and Friday’s November non-farm payrolls report.

On Monday, MarketWatch interviewed St. Louis Federal Reserve Bank President James Bullard. Tuesday comes the S&P Case-Shiller US Home Price Index, FHFA US Home Price Index, and November Consumer Confidence.

do not miss: Fed’s Bullard is scheduled to speak on inflation and interest rates at a MarketWatch Q&A on Monday

Key data releases on Wednesday include the ADP employment report, a revision of Q3 GDP, the Chicago PMI, October job openings and layoffs updates, and the Fed’s Beige Book report. Federal Reserve Chairman Jerome Powell is scheduled to speak at the Brookings Institution.

The batch of data released on Thursday includes the Weekly Unemployment Claims, the October Personal Consumption Expenditure Price Index, the S&P US Manufacturing PMI, and the ISM Manufacturing Index. On Friday, November’s non-farm payrolls and unemployment rate will be released.

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