A Santa Claus rally in stocks may fizzle this year, and that means 2023 returns are at risk and any gains likely hinge on the Fed cutting rates
- A Santa Claus rally has yet to materialize on Wall Street this year, and that's bad news for the stock market.
- "When the index is down in the double digits as it is today, the odds of it being positive next year is essentially a coin flip," DataTrek said.
- DataTrek said any stock market gains in 2023 likely hinge on the Federal Reserve cutting interest rates.
The stock market's weakness in 2022 could very well spill over into 2023 as a Santa Claus rally is unlikely to dig the S&P 500 out of its 19% year-to-date loss, according to DataTrek Research.
The window for a Santa Claus rally on Wall Street doesn't open up until the last five trading days of the year, which begins this Friday, and spills over into the first two trading days of next year. But as long as the S&P 500 ends 2022 down 10% or more, investors should practice caution about getting too excited about a rebound in 2023.
"When the index is down in the double digits as it is today, the odds of it being positive next year is essentially a coin flip and the returns aren't nearly as promising as they would be if the S&P ended down less than 10%," DataTrek co-founder Jessica Rabe said in a Tuesday note.
The win rate for the stock market in the following year falls from 79% to 55% when the S&P 500 ends the year down more than 10%, and the average return in the following 12 months falls from 17.5% to 6.4%, according to Rabe.
"If there had been a real 'Santa Claus rally' this month, the S&P might have ended the year with less than a double-digit decline. Things have not turned out that way thus far, and this may be telling us something important about 2023," Rabe said.
From a fundamental perspective, investors have plenty to worry about in 2023, as concerns grow about an imminent recession, a decline in corporate earnings, and a Federal Reserve that remains focused on fighting inflation via hiking interest rates.
But while the Fed is driving part of the ongoing risk-off nature of the stock market, it is also the key catalyst that could spark a turnaround for the stock market in 2023, according to Rabe.
"As for what turns US equities around after a hard year, the essential ingredients are: help from the Federal Reserve in the form of lower interest rates or Federal government spending," Rabe said, pointing to the Financial Crisis of 2008 and 2009 as a more recent example.
"When times get truly difficult, fiscal and monetary policy stimulus can help the S&P rebound after a horrible year," Rabe said, noting that while the S&P 500 fell 37% in 2008, it rebounded 26% in 2009.
"That's why US equities are so volatile now, as no one knows when the Fed will pivot to being more accommodative," Rabe said.