The traditional December bounce for stocks may be more elusive, but it’s still possible

Published Wed, Nov 30 202212:38 PM ESTUpdated Wed, Nov 30 20221:41 PM EST

Patti Domm @in/patti-domm-9224884/@pattidomm

Another Federal Reserve rate hike and worries about the economy could hobble stocks heading into the end of 2022, but strategists say there's still a chance December's traditional seasonal rally could prevail. The Covid-19 lockdowns and unrest in China were added to the market's concerns this week. The S & P 500 traded near the flat line Wednesday, but it's on track for a higher November, with a gain of more than 2%. Many strategists expect the market to be choppy into the first half of next year, possibly testing its lows again as the central bank continues to raise interest rates. The Fed's next meeting is Dec. 13 and 14 , and it is widely expected to raise its target rate by a half percentage point at that time. "Historically, December is the best-performing month, rising 77% of the time," said Sam Stovall, chief investment strategist at CFRA. "Yet, Decembers during midterm election years saw a step down in returns." In those years, December was just the fourth-best month, with the S & P 500 rising 1.35% and gaining 68% of the time. Lackluster performance ahead? As the S & P 500 exits November, it is down about 17% this year. Based on the performance of the 10 worst years through November, December could be lackluster. "This is the fifth worst year-to-date performance since World War II," said Stovall. The only other years that were worse were 1973, 1974, 2002 and 2008, he added. Stovall said the returns for those Decembers were mostly positive but lackluster. In those Decembers following the 10 worst year-to-date returns through November, the S & P 500 fell an average 0.33% and was higher 60% of the time. "In three of those four, a year later in 1975, 2003 and 2009, things were a lot better," he said. Like many strategists, Stovall sees a volatile and potentially down market in the first part of next year, but December could still be a positive. Small caps, mid caps, and value stocks are often outperformers in the month, while the Nasdaq Composite and growth stocks were typical underperformers, he noted. "I think that we end up doing well," said Stovall. "The likelihood of a positive final month of the year may be good but not great because we are going to worry about an earnings recession. Q4 is expected to show a 2% decline year-on-year earnings. We're going to worry about the Fed maintaining its hawkish stance and the magnitude of the impending recession." The S & P 500 could mirror some of the other very negative years. For instance, the S & P 500 was down 18.5% through November in 2002, and then bottomed in March 2003, gaining 26.4% that year. Seasonality and potential tail winds Quincy Krosby, chief global strategist at LPL Financial, said there are risks from the Fed's rate hiking and a possible recession. But stocks could still move higher in December. "Seasonality is the strongest during this period. The Santa Claus rally goes through January. It's predicated on new money coming in," said Krosby. "What's happened over the years is institutional money managers, knowing they're going to be receiving funds and having to allocate, begin the allocation process before the new year. That adds to the volume before the end of the year." She said the market could also see a positive in upcoming inflation reports. The personal consumption expenditures inflation data is released Thursday, and the November consumer price index is reported Dec. 13. "If we continue to surprise with cooler reports, the PCE and the CPI, it could absolutely lead to and underpin a Santa Claus rally," said Krosby. "The bears are going to define that as a bear market rally, but it could serve as a strong catalyst to move the market higher." Stephen Suttmeier, Bank of America's technical research strategist, said the period starting on the day before Thanksgiving is typically strong, but the S & P 500 needs to overcome some milestones before it can really head higher. Since 1928, the S & P 500 has been up 71% of the time between the Wednesday before Thanksgiving and Dec. 31, for a gain of 1.5%, he said in a recent note. "Within this period, Christmas Eve through New Year's Eve is up a greater percentage of the time than Thanksgiving through Christmas Eve, which reflects the Santa Claus rally," he wrote. Watching key levels In order to confirm a bullish cycle, Suttmeier said the S & P 500 needs to regain the 40-week moving average at 4,033. If the index cannot hold 3,900 and then the lower levels of 3,860 to 3,818, it would potentially mean the S & P could revisit other lows. That would include its 200-week moving average of 3,646 and then it would be at risk of returning to its 2022 low of 3,491. "Maybe, it's not December, but I would say a lower low is likely," said CFRA's Stovall. He said the bear market has been shallower than most, and there has not yet been a big capitulation. There are also geopolitical threats hanging over the market, with both China and the Russian war in Ukraine as potential sources of volatility. "Maybe they could they come up with a cease-fire in Ukraine, and everything would take off, but [Russian President Vladimir] Putin may want to save face first and use tactical weapons," said Stovall. "There's so much stuff that could go either way." Stovall said positives for the market next year would be if the Fed were to stop hiking and even begin cutting interest rates toward the end of 2023. That could also slow or reverse the dollar's gains, which would also help stocks. Ari Wald, Oppenheimer's head of technical analysis, said he has a more optimistic view of the market in the near term and into next year. He said investors' concerns and the charts he watches are not aligned. "There's a bit of a conflict between the technicals and what the fundamental catalysts would be to support what's setting up to be a breakout in the charts," he said. "This is a very classic market bottoming behavior. But what's the catalyst going to be to help the market push through the 2022 downtrend and the 200-day moving average? The risks have been a GDP recession, and earnings recession and valuations, and we've looked at all those ideas. That all lags the market." Wald said the market's internal breadth is improving, and sectors like industrials and financials are decoupling from the broader market. "Areas that didn't do well in the Q3 slide now have broken higher. The setup is there. Seasonals are supportive as well, but the catalyst is unknown," he said. "Prices move first and then you fill in the blank as to what caused the move. If you look at what caused the downturn this year, a lot of those risks are in the rearview mirror and are starting to abate. We think the market surprises higher." Wald said his time horizon is the next three to six months, but December's performance could be helped by the seasonal factors. "Next four weeks? We'll see. It'll be a period of the year where it would be reasonable for the markets to move higher," he said.