The stock market's momentum appears to have stalled in December, with the S&P 500 sitting on a monthly loss heading into the final full week of the calendar year. But that doesn't mean a hoped-for "Santa Claus rally" won't materialize, according to analysts.
For reference, the Santa Claus rally refers to a seasonal pattern in which stocks have historically tended to rise during the last five trading days of December and the first two trading days of January. This year, it begins on Dec. 24, Christmas Eve.
A late-year rally, if it materializes, could help set the tone for markets heading into the new year, as investors debate how much longer a bull market that has already lasted more than three years can continue.
For decades, Wall Street has treated this stretch as a barometer of market confidence. Historically, the absence of a year-end rally has carried a warning signal. As the late Yale Hirsch, the market analyst who developed and popularized the concept, once put it: "If Santa Claus should fail to call, bears may come to Broad and Wall." (The New York Stock Exchange famously sits at the corner of Broad Street and Wall Street in lower Manhattan.) In other words, if stocks fail to rise during this typically strong period, it can signal lingering caution among investors heading into the new year.
The artificial-intelligence trade has come under pressure recently, contributing to the stock market's woes. But despite these recent troubles, some strategists say the setup for a year-end rally remains intact. The big question: Will the S&P 500 SPX see another record finish before the year's end? The index tallied its 37th record finish of the year on Dec. 11, when it closed just above 6,900, Dow Jones Market Data showed.
"It looks like [the Santa Claus rally] is set up and we can make another high by the end of the year," said Jeffrey Hirsch, editor-in-chief of the Stock Trader's Almanac and Yale Hirsch's son.
Santa rally secured?
Analysts have pointed to a few reasons they believe stocks are set to trudge higher into New Year's Day.
Economic reports released over the past week showed signs of cooling inflation and slower job growth in November - developments that may give the Federal Reserve more room to cut interest rates next year, Hirsch noted in a phone interview. Falling interest rates tend to boost investors' appetite for risk assets like stocks, Hirsch said.
History is also on the side of the Santa rally, as a weak start to December has not typically derailed it. Since 1950, even in years when the S&P 500 posted a negative performance earlier in December, the index still finished the Santa Claus-rally period higher in 20 out of 26 instances, or 77% of the time. That is the same win rate as the total for all years - which has seen the S&P 500 rise during the Santa-rally period 77% of the time, delivering an average return of 1.3% during that period, according to Dow Jones Market Data.
Recent price action also suggests that the market could soon be heading higher, Hirsch said. For the past two weeks, markets have experienced some pullbacks after becoming slightly overbought, but key support levels have largely held. "That kind of pullback around this time of year is typical, and it sets us up for that Santa Claus rally," he said.
U.S. stocks ended last week mixed, with the Dow Jones Industrial Average DJIA down 323.16 points, or 0.7%, for the week to end at 48,134.89. The S&P 500 edged up 7.09 points, or 0.1%, on the week to close at 6,834.50, while the Nasdaq Composite COMP rose 112.45 points, or 0.5%, last week to finish at 23,307.62.
Stock rally broadens out
To gauge whether stocks could stage a Santa rally and extend gains into next year, investors are watching whether broader participation can persist, as gains have spread beyond a narrow group of Big Tech stocks.
Banking shares, for example, have continued to outperform the broader market so far this month, even as tech stocks lagged. Outside of the large-cap space, the Russell 2000 small-cap index RUT has also outperformed the S&P 500. An equal-weighted version of the S&P 500 index XX:SP500EW, which effectively tracks the performance of the average S&P 500 stock, has also done better than its capitalization-weighted sibling, in more evidence that the rally has started to broaden out.
The rotation so far suggests that major indexes like the S&P 500 can in fact stomach some weakness in major tech names, as long as stocks in other sectors can pick up the slack.
"The real leadership actions from the banks are good from a market perspective, because it allows the AI sentiment to reset without needing a big 10% pullback in the broad market," said Ross Mayfield, investment strategist at Baird, in a phone interview.
Other cyclical sectors tell a similar story, Mayfield said. Industrials, materials and consumer-discretionary stocks tend to be more closely tied to investors' views on economic strength. "If those stocks are rallying alongside AI stocks or in lieu of AI stocks, I think it says something about how investors are viewing the economic backdrop into next year, which is positive," he said.
AI valuations still a risk
Even so, optimism around a year-end rally is not without caveats. Investors continue to debate whether stocks tied to artificial intelligence have become too expensive, particularly given the scale of capital spending being deployed to support AI infrastructure, said Brian Mulberry, senior client-portfolio manager at Zacks Investment Management.
While Mulberry does not think AI stocks are currently in a bubble, he noted that investors should watch for any warning signals.
"The amount of money that has been committed to this AI infrastructure is really fueling the big multiple that we have in valuations on the market right now," he said. "If that capital does not get spent or invested the way that it's been announced, it will be a big negative drawdown for the markets."
One warning sign, in particular, caught investors' attention last week: Asset manager Blue Owl Capital $(OWL)$ reportedly pulled out of Oracle's $(ORCL)$ $10 billion data-center project, citing concerns over the tech company's rising debt levels and heavy AI spending, according to a Financial Times report.
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