Wall Street expects 'Santa Claus Rally' as US stocks approach record highs

As 2023 draws to a close with impressive gains, Wall Street is pinning its hopes on the traditional 'Santa Claus Rally' to propel US stocks to new record highs. The S&P 500, up over 4 per cent in December alone and boasting a 24 per cent increase for the year, stands within 1 per cent of its all-time peak, setting the stage for a potential historic year-end surge.

The 'Santa Claus Rally,' a historical market phenomenon, typically sees strong performance in the last days of December and the first days of January. Historical data from the Stock Trader's Almanac, dating back to 1969, reveals that the S&P 500 has, on average, gained 1.3 per cent during this period. Reasons behind this trend vary, ranging from year-end buying ahead of tax-related sales to an overall sense of holiday optimism.

This year, optimism is particularly buoyant, fuelled by the Federal Reserve's unexpected dovish pivot earlier in December. The central bank signalled the likely conclusion of its historic monetary policy tightening and projected rate cuts into 2024, responding to indications of ongoing moderation in inflation. Recent data showing a further slowdown in annual US inflation in November has added to the positive sentiment.

Angelo Kourkafas, Senior Investment Strategist at Edward Jones, highlighted the prevailing narrative, stating, "The narrative will continue to be about the Fed making a dovish pivot. That provides support on markets and sentiment and is unlikely to change next week."

Investors, exhibiting a robust appetite for stocks, recently witnessed the largest weekly net inflow since October 2022, with BofA clients buying $6.4 billion of US equities on a net basis. Retail investors have also significantly increased their buying activity over the past four to six weeks, redirecting their purchases towards riskier securities amid a softening yield environment.

Acknowledging the positive market breadth, Ned Davis Research recommended a further 5 per cent shift from cash to equities, bringing equity allocations to their maximum level in portfolio models.

However, as the year concludes, thin trading volumes are expected due to holiday breaks, potentially leaving the market vulnerable to unexpected news or significant trades. Recent market moves, such as the S&P 500's sudden 1.5 per cent drop on Wednesday, have been attributed to factors like low volumes, activity in zero-day options and institutional investor trades after an extended period of gains.

Kevin Mahn, President and Chief Investment Officer at Hennion & Walsh Asset Management, noted that investors heavy in cash might be driven by the 'fear of missing out' (FOMO) to join the equity rally next week. Despite concerns of markets being ahead of themselves, Mahn sees potential for a slight upward movement, fueled by the FOMO trade.

(With Reuters inputs)