After a sizeable 8.3% rally in October, stocks went nowhere in November, bouncing around in a trading range with the S&P 500 gaining less than 0.5% last month. But we are now in the midst of what has historically been the strongest season of the year for stocks.
Does this mean new stock market highs before New Year’s? Well, not so fast.
Indeed November through January is historically the best three-month period of the year to invest in stocks. Since 1928, the S&P 500 has gained an average of 3.4% over this stretch, with positive returns two-thirds of the time.
Since 1950, the months of November and December are the two best months of the year, as the fabled Santa Claus Rally kicks in. In fact, the final 30 trading days of the year, which began just before Thanksgiving, has seen stocks trend higher for the past 12 years in a row.
But a year-end rally isn’t always in the cards and the timing can often be tricky.
Last year, for instance, the S&P enjoyed a Santa Claus Rally of 6% from Dec. 16-29, but stocks fell 5% in early December just prior to the rally. And stocks rolled over again suffering another 5% loss in early January.
This year, investors have the added drama of a Federal Reserve policy meeting on Dec. 15-16 to deal with. The Fed is widely expected to raise rates, with Fed funds futures contracts currently pricing in a 77% chance of a rate hike at this meeting.
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Could this derail a year-end stock market rally? Perhaps, but that outcome isn’t very likely for two reasons.
First, a Fed rate hike has been widely telegraphed to the market already ever since October’s bullish jobs report. Of course there’s another employment report on tap this Friday morning, and it’s possible that a disastrous result could stay the Fed’s hand.
Second, historically speaking, rising interest rates have not fazed the stock market much, at least not early on in the rate hike cycle. Since the 1950s, stocks move higher, not lower, by an average of 4.1% in the six months following the Fed’s first interest-rate increase. And stocks go on to gain 9.5% 12 months after the first rate hike, which is typically followed by more than one.
Today’s Federal Reserve is so hyper-sensitive to what would be the first increase in short-term rates in nearly a decade that they’re likely to err on the side of caution about subsequent rate hikes.
In fact, many pundits still believe the Fed could blink in December, or if they do raise rates, it may be a one-and-done move with the Fed pausing for a while — perhaps well into 2016 — before hiking rates again.
But this four-year cycle could keep a lid on stocks
Stocks may drift higher this month as investors are filled with holiday cheer, in spite of, or perhaps because of the Fed. But that doesn’t mean the market will make a beeline toward new highs either.
That’s because another powerful season tendency is at work right now that could keep a lid on the stock market well into 2016: the four-year Presidential cycle.
The chart above from Merrill Lynch graphically displays the historical incumbent Presidential cycle pattern. Note the red dotted rectangular box at right shows the phase of the four-year cycle that began in July and continues through year #4 (the election year).
This is the weakest part of the four-year cycle!
Typically stocks peak around mid-year of year #3 and choppy trading range conditions follow right through the end of the election year. Sure enough, the S&P 500 peaked in May, just prior to mid-year 2015.
If stocks keep following this pattern, you can expect more up-and-down volatility in the months ahead, and perhaps even a steeper market decline into year-end 2016.
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