End of year gathering? Stock market uptrend set to come up against stagflation fears

Dow industrial DJIA,
+0.45%
jumped nearly 20% from a late-September low on the cusp of the threshold that would mark an exit from a bear market, while the Nasdaq Composite performed poorly as investors remain on hold the December Federal Reserve rate decision, other inflation data and geopolitical risks abroad.

Major indexes posted gains in a holiday-shortened Thanksgiving week, with the Dow Jones up 1.8%, the S&P 500 up 1.5% and the Nasdaq Composite up 0 .7%.

And then there is a seasonal year-end tailwind. According to Dow Jones Market Data, the S&P 500 rose 71% of the time between Thanksgiving and year-end, based on numbers dating back to 1950. On average, the large-cap benchmark rose 1 .8% during this period. . This data may be an approximate guide for investors, but is not a guarantee of performance in any given year, as illustrated by the red lines in the graph below.

And this favorable seasonal pattern could come up against fears that 2023 will bring stagflation: the worst economic outcome possible and for which investors would find it difficult to prepare. Stagflation is defined as a period of slow economic growth and persistently high inflation, a dynamic that may already be underway in the United States.

Warnings of a possibly deep U.S. recession ahead are flashing steadily in the bond market, where the widely followed gap between 2-TMUBMUSD02Y,
4.508%
and the 10-year Treasury yields TMUBMUSD10Y,
3.700%
remains close to minus 80 basis points, which means that the 10-year rate is almost 0.8 percentage point below the 2-year yield. Last week’s curve hit its deepest inversion since 1981. Such inversions are considered a reliable indicator of recession.

US growth turned positive again in the third quarter and inflation appears to be easing, judging by the October consumer price index in which the headline annual rate fell to 7.7% vs. 8.2% previously. Yet the price gains are not fast enough for the Federal Reserve to completely abandon aggressive rate hikes, which could tip the world’s largest economy into a slowdown.

“The tricky part for investors in a stagflation scenario would be confusion over where to invest,” said Mark Neuman, founder of Atlanta-based Constrained Capital and creator of the ESG Orphans Index, which tracks stocks with $3 trillion in combined market capitalization.

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

Adding to last month’s bullish tone in equities are stronger than expected retail sales in October and a weaker than expected producer price report, both of which show that “the economy is holding up well, despite the continuous rise in short-term markets”. -term rates,” said Sam Stovall, chief investment strategist for CFRA Research in New York.

“Seasonality will provide a little boost to stocks towards the end of the year, and I think investors are expecting the Federal Reserve to rise 50 basis points in December and maybe not be so hawkish in his statement,” Stovall said via phone. “Right now the stock market is assuming we’re not going into a recession or, if we do have a recession, it will be mild and the Fed will likely lower interest rates in the latter part of 2023.”

He said the CFRA economic outlook calls for the U.S. economy to narrowly miss a recession, while falling into stagflation, followed by a U-shaped rather than a V-shaped recovery.

“If the direction of inflation continues to be down – meaning a gradual but steady decline – that would be enough to make investors feel pretty good in my opinion,” Stovall said. at MarketWatch. “Furthermore, we expect improved corporate earnings growth heading into 2023.”

According to Stephen Suttmeier, chief technical equity strategist for BofA Securities, the last 10 trading sessions of December through the first 10 sessions of January have proven to be a bull run for the S&P 500, time and time again: the index is up 72% of the time on an average return of 1.19% over the last 10 December trading sessions, he said. This strength tends to carry over into the new year, with the S&P 500 up 64% of the time on an average return of 0.72% in the first 10 days of January.

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Along with these year-end seasonal factors comes a well-known pattern that saw equities achieve their best performance in a six-month period beginning in November.

According to strategist Rob Anderson and analyst Thanh Nguyen at Ned Davis Research, the six-month period from November to April tends to particularly favor stocks in a range of cyclical stocks. NDR’s broad cyclical index, which includes the industrials, consumer discretionary and materials sectors, outperformed a defensive basket of basics, healthcare, utilities and telecommunications companies, on average , between these six months since 1972.

They also said technical reasons favored a year-end rally in US equities, while noting that “external forces may overwhelm seasonal trends.”

Highlights for the week ahead include Thursday’s release of the Fed’s preferred inflation gauge for October and Friday’s nonfarm payrolls report for November.

On Monday, MarketWatch interviews St. Louis Fed President James Bullard. Tuesday brings the S&P Case-Shiller US Home Price Index, the FHFA US Home Price Index and the November Consumer Confidence Index.

Don’t miss: Fed’s Bullard Set to Talk Inflation and Interest Rates in MarketWatch Q&A on Monday

Wednesday’s key data releases include the ADP jobs report, a third-quarter GDP revision, the Chicago Purchasing Managers’ Index, job openings and quits updates for October. and the Fed’s Beige Book report. Fed Chairman Jerome Powell is also expected to speak at the Brookings Institution.

Thursday’s batch of data includes weekly jobless claims, the October personal consumption expenditure price index, the US S&P manufacturing PMI and the ISM manufacturing index. On Friday, November data on nonfarm payrolls and the unemployment rate are released.