How have US stocks performed amid Santa rally’s onset?

After five straight record closing, US stocks saw a slight decline; however, all three major US indexes ended the day down. Wall Street was expecting the Santa Rally to push markets to new heights as they finish 2023 on a high note. With a 24% increase so far this year, the S&P 500 is on course for its eighth consecutive positive week and is just 1% away from a new all-time high.

If history is any useful guide, that stocks’ momentum is likely to continue in the short-term. The end of the year tends to be a strong period for stocks, a phenomenon known as the Santa Rally.

History speaks, so investors listen and learn that Santa rally started last Friday. The S&P 500 on average has gained 1.3% in the last five days of December and first two days of January, according to data going back to 1969. These gains have been attributed to a variety of factors, including overall holiday optimism and purchases made before to the new year in response to tax-related sales.

Trading volumes are expected to be thin for the remainder of the year as investors take holiday breaks, leaving stocks particularly sensitive to unexpected news or large trades. One example of outsized moves was the S&P 500 taking an abrupt turn lower on Wednesday afternoon, closing down 1.5% on the day.

The Commerce Department’s Personal Consumption Expenditures (PCE) report showed inflation continues to meander down toward the Fed’s average annual 2% target. A separate report showed new orders for core capital goods landed well above analysts’ expectations, well for US corporate spending plans. These data reinforce the conviction that the central bank might begin cutting interest rates as early as March 2024, but it might pull off reining in inflation without tipping the economy into recession, a “soft landing.”

On Wednesday, the US market indexes—the Nasdaq, S&P 500, and Dow—saw their worst day in months, with only 19 S&P 500 firms rising. Following the release of their results, FedEx shares, General Mills, and small-cap companies all declined. Bond yields decreased; for the first time since late July, the 10-year yield ended below 3.9%. With futures traders projecting a better than 70% possibility of lower rates by March, investors are still confident about a rate decrease in March. Futures for Brent crude increased to slightly under $80 per barrel.

The US economy is strong and doesn’t need lower rates at the moment. Financial markets are pricing in a 74.1% likelihood that the Fed will implement a 25 basis point rate cut in March, according to CME’s FedWatch tool.

The Fed has signaled that its historic monetary policy tightening is likely over and projecting rate cuts into 2024, following signs of moderate inflation. This has led to a high level of optimism among investors, with Bank of America’s clients buying $6.4 billion of US equities on a net basis in the latest week, the largest weekly net inflow since October 2022. Retail investors have also shown a sharp increase in buying over the past four to six weeks.

The FOMC’s signals and strengthening soft-landing narrative have led individuals to redirect their purchases towards riskier securities, which is expected to continue into the new year as yields remain under pressure.