What Will December Bring For Stocks And Investors?
December is typically a good month for stocks. From 1980 to 2018, the average return for December has been 1.11%, making it the third best month of the year behind April and November. That average, though, conceals some pretty wide variations. Last year, for example, the S&P 500 lost around 16% in the first three weeks of the month before bouncing back on a pretty significant Santa Claus rally, so it could be argued that what characterizes the month is big moves, not necessarily in any one direction.
In fact, if you look at one of the generally accepted explanations for a Santa Claus rally, that pattern makes sense. The term refers to the relative strength in stocks in the last 5 trading days of the year and the first two in January. It is often said that it is a reaction to selling for tax and year-end positioning purposes, making stocks unduly cheap. If that is the case, December is really about volatility, not just gains.
So, if big moves are more likely in December, that raises an obvious question for investors: What can we expect this year?
The Technical Picture
To be honest, hovering around record highs, the chart tells us very little. Your read comes down to whether you are a momentum person or more of a contrarian. The momentum argument rests on the fact that there is still a large amount of cash on the sidelines. As we march ever higher, the FOMO factor should kick in, accelerating the gains. The contrarian argument comes down to "what goes up must come down." Markets don't often move in straight lines, so at some point there has to be an adjustment.
Neither of those is a particularly convincing argument, and December’s market moves will more likely be in response to fundamental rather than technical factors, so let’s look at the bull and bear cases for those.
The Bull Case
The U.S. economy is strong. Unemployment is at record lows, growth is steady if not spectacular, and both business and consumer confidence are at positive levels, yet inflation is still low. Consumer spending has increased every month since March of this year, setting up for a strong holiday season.
More importantly for stock prices in the short term, the last earnings season saw an above average 72% of S&P 500 companies beating expectations. And at 17.5x earnings, the market does not look overly stretched.
There are indications that the big overhang of trade may be nearing a resolution. A Phase One deal with China is expected this month, which would obviously give the market a boost. The global growth outlook is also improving, as evidenced by the unexpectedly high numbers for Chinese factory production released over the weekend.
In addition, interest rates are still low. A return of below 2% on the U.S. 10-Year makes stocks a far more attractive proposition than bonds.
Given all that, why wouldn’t stocks keep moving higher?
The Bear Case
Underneath the seemingly strong economy, there are warning signs. U.S. manufacturing is definitely feeling the effects of tariffs, and the sector is technically in recession after four consecutive months of negative growth. Businesses aren’t investing, suggesting that they are less optimistic about the future than you might think. Capital expenditure fell by 3% in the third quarter of the year, following a 1% decline in Q2.
All of that could be rectified by a trade deal, but are we really any closer to one? We have been hearing for a long time that a deal is coming, but it seems that each step forward is followed by two back, and the recent U.S. act of Congress supporting the pro-democracy protests in Hong Kong makes a deal less likely now than just a few weeks ago.
It could also be argued that there are warning signs in other markets. Commodity prices remain relatively low and the yield curve, while no longer fully inverted, is still pretty much flat out to 5 years, indicating no expectation for a surge in growth.
Then there is the political situation. Whether you agree or not with the current administration, the market has shown a lot of confidence in Trump’s policies. However, with impeachment hearings continuing and an election coming up in 2020, there is that degree of uncertainty on the political front.
At some point, the negatives have to weigh on the market, but as a general rule, it is better to invest based on what is happening, rather than what might happen. The stock market has been facing the worries that make up the bear case for some time, yet here we are, near record highs. Unless the possible problems become a reality or the Fed unexpectedly reverses course, it is reasonable to assume that December will bring more of the same and that stocks will continue to edge higher, albeit with some volatility thrown in.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.