“The month of December maybe the one month on the calendar each year which most often repeats its seasonal pattern. Given the mixed outlook of our supporting data, we will lean on the historical seasonality of December as our expectations for the month. We are to expect the first two weeks of the month to be relatively flat, then a strong finish through the end of the month and the year.”
It took a bit longer than expected, but the December market returns met our expectation. Basically, flat for the first 14 trading days of the month, December closed very strong as all the major indices added more than 4% the last 8 trading days of the month and year. This strength also helps confirm the annual “Santa Claus Rally,” which is represented as the price actions of the S&P 500 over the last 5 trading days of the year and the first 2 trading of January. The old market slogan states, “If Santa Claus should fail to call, bears may come to Broad and Wall.” The S&P just posted a positive gain of 1.5% over this time period which should be viewed as encouraging.
December Best Sectors
December Worst Sectors
January Historical Data Points
January has historically been a reliable barometer for the current year’s stock market return. Since 1950, the following market actions have offered excellent indicators to include in our probability analysis:
S&P gains during the first five trading days of January precede full-year gains roughly 82% of the time.
S&P gains during the entire month of January precede full-year gains roughly 74% of the time.
Every down January in the S&P since 1950 (except 2021), precedes a new or extended bear market, a flat market, or a 10% correction during the year.
January is overall the best month for the Nasdaq, while the other averages have slightly better than averaged returns for the month.
The Mid-Term Year
The market has now entered the 2nd year of the Presidential Cycle, otherwise known as the “Mid-Term” year. Traditionally, the market is flat to down all the way into the midterm elections held in November, before rallying higher to close out the year. The chart below shows several different political scenarios for the midterm market, dating back to 1946. The red line is the most important line to look at, it represents the average S&P 500 performance in midterm election years during the 2nd year of a new Democratic president, which we have with President Biden. Historical expectations are for the S&P to close slightly negative based on this statistic.
The second year of the Presidential Cycle is usually the weakest year of the 4-year cycle as many of the campaign promises from the election campaign are finally acted upon. The smooth sailing of the market in President’s Trump’s first year in office, changed quickly in year two when he started raising his promised tariffs on China. Historically, the second year of the cycle is weaker for first term presidents, no matter the party.
As we enter President Biden’s 2nd year in office, there are no clear overhanging policy issues that standout that could be of major concern for the market. Outside of the “Build Back Better” bill, it seems like any weakness in 2022 will have to be attributed to external issues and not policy implementation issues. Front and center is going to be the Fed and their desire to normalize rates. We did get an increase in tapering from the Fed in December, but from our work, it seems like much of this has already been priced into the market.
It will be interesting to see what issues arise, if any, that could cause the market to maintain its seasonal pattern in the midterm year. No matter what type of market action there is throughout the first ten months of the year, there is almost always a strong post-election rally into the end of the year and throughout the third year of the Presidential Cycle.
January Market Expectation
Unlike the past few months, we have seen several of our technical indicators improve heading into January, offering us some hope that the month will present positive returns. We saw a significant increase in liquidity over the last two weeks of December indicating an increase in demand for stocks. Money flow data for the month of December showed an almost 20% improvement from the end of November, the second largest month gain in 2021.
While its great to see our indictors improve, even as the Fed raised the level of their monthly taper in December, some fundamental aspects of the market are a bit more concerning. For example, we are expecting earnings growth to peak during the upcoming 4th quarter earnings season, as earnings begin to normalize after accelerating out of the 2020 shut down. In the 12 months following earnings peaks, the defensive sectors traditionally outperform, being led by Real Estate, Utilities, and Staples. These were the three best sector performers for the month of December.
The macro side of the economy is already signaling a potential slow down in overall growth. Again, this slowdown is coming from an area of strength, so more of a normalization. As an example, the Manufacturing PMI (Purchasing Managers Index) has been decelerating for the last few months, a clear signal that growth has been slowing. Looking into regional manufacturing data we continue to see items such as Prices Paid, Prices Received, Delivery Times, and Unfilled Orders, move to the downside. On the negative side, this data is lower due to economic growth. But it is also a major positive because it indicates that the supply chain issues are easing, which should help lead to lower inflation moving forward.
History shows that we are entering a market environment which is going to be a bit more difficult than what we have seen over the last 18 months - but this does not mean that the market is going to suddenly crash.
There will be a few more dips along the way, but we are rather confident that these dips will not be much of an issue. Coming out of such a strong pervious year, strength usually bleeds into the first few weeks of January. The last week of the month could bring some volatility as the Federal Reserve meets. However, we are not expecting any major changes from the Fed after their December taper increase. So, look for a few steady weeks here as we kick-off 2022 and a bumpy road to the midterm elections. It could be a good year to focus on dividend income instead of price growth for many investors.