Stocks: Santa Likely To Lift Stocks In December, But The Calendar, Sentiment Pose Risks Early Next Year
December 2024
If history is any guide, U.S. large-cap stocks should have the wind at their sails into year-end as the S&P 500 attempts to close out 2024 with a greater than 30% total return. Liquidity remains ample and supportive of further gains, evidenced by a continued lift in prices of riskier asset classes of late. Shorter-term measures of S&P 500 participation have deteriorated in December but around two-thirds of S&P 500 constituents still traded above their respective 200-day moving average as of mid-month. We would characterize breadth readings on the S&P 500 as falling somewhere between good enough and solid at present, but we will be watching for further signs that leadership is faltering and narrowing, potentially a sign that a pullback of some magnitude is in the works. With this backdrop in place, market participants have few reasons to fight the prevailing uptrend in U.S. large-cap stocks into January, and with tax rates on capital gains unlikely to rise in 2025 investors could push sales into the next tax year, lessening one headwind for stock prices that comes into play at year-end.
With that said, the positive seasonal backdrop currently in place for stocks often shifts in late-January. The S&P 500 has historically faced tough sledding in the month of February, generating a -0.09% average return during the month dating back to 1928, making it one of only three calendar months to generate, on average, a negative return. Bullish sentiment approaching the highest level seen this year is another risk worth watching as a contrarian indicator. Sentiment surveys are far from a perfect guidepost when it comes to accurately signaling market tops or reversals, particularly during the month of December, and after strong year-to-date gains, holiday cheer can boost sentiment, risk appetite, and stock prices to unexpected levels, but sentiment could shift early in the new year as investors rebalance portfolios.
Year-To-Date Winners Have Historically Been Left Out Of Year-End Rallies As Investors Chase Beta. December has historically been a positive month for equity market, but factor exposures haven’t all fared so well during the month, with momentum and quality generating negative returns, on average, during the month over the past decade. That fact flies in the face of the conventional wisdom that year-to-date winners keep on winning and carry the leadership baton through year-end, but it has been more volatile, higher beta stocks that have fared best in December in recent years. Up to this point in the month, we’re seeing this dynamic play out yet again as the iShares Momentum ETF (MTUM) has declined by 1.6% while Invesco’s S&P 500 High Beta factor ETF (SPHB) has rallied by 1.8%. Momentum-based strategies tend to be populated with stocks in a longer-term uptrend, often over the previous 6- or 12-months, while beta products attempt to allocate to the stocks with the greatest sensitivity to market movements, both to the upside and downside. Portfolio managers window dressing and stretching for alpha at the last minute is one possible driver of a year-end beta rally. While we wouldn’t be surprised if more volatile names of questionable quality lead in the coming weeks, chasing those names could prove to be costly if market sentiment shifts.
Will Trump 2.0 Mean More Of The Same (Underperformance) For SMid? Investors dusted off their 2016 playbook in the wake of the November elections, reigniting interest in smaller companies and propelling the S&P Small Cap 600 to a 10.9% gain in November alone, nearly doubling the S&P 500’s monthly return. The small cap advance rhymed with what occurred in November of 2016, when the small cap index surged by 12.5%, but companies farther down the market cap spectrum had also led for most of that year up to that point and were in a different fundamental position than they appear to be in today. The potential for a more volatile global trade backdrop in the coming years alone begs the question, is the rotation into SMid for real, or set to fade as it did during President Trump’s first term?
It’s no secret that small- and mid-cap companies rely less heavily on foreign sales to drive profits, and in an environment where U.S. tariffs on imported goods could rise, and with our trade partners potentially responding with tit-for-tat tariffs on U.S. imports, smaller companies should be relative beneficiaries. However, that wasn’t the case in 2017, the year tariffs were implemented in President Trump’s first term, as the S&P 500 outpaced the S&P Small Cap 600 by 8.6% as, despite the political sparring, the ultimate outcome posed less of a headwind for financial markets and multinational based in the U.S. than feared. SMid cap stocks carry attractive valuations relative to their expected earnings growth in the coming year and should provide some insulation in a tail-risk trade scenario if trade/tariff rhetoric ramps up, but macro tailwinds may not be enough to win over investors and turn them into believers. We are optimistic that an uptick in mergers and acquisitions (M&A) and deregulation will boost SMid in ’25, but they will also provide tailwinds for companies in the S&P 500 as well. We recommend allocations to both U.S. large-caps and U.S. SMid that fall in-line with our strategic allocations as a result.
Shorter-Term Breadth Measures Improving Abroad, Supportive Of A Lift Into Year-End For Developed Markets Abroad. Measures of participation or market breadth stateside have allowed us to remain constructive on U.S. stocks over the balance of 2024. But those same measures or metrics have been more mixed for developed and developing markets abroad, which has led us, and many other investors, to the conclusion that the U.S. remained the place to be for investors looking to take equity risk. However, breadth measures have noticeably improved abroad thus far in December with over three-quarters of the constituents of the Euro Stoxx 50, CAC 40 in France, German DAX, Hong Kong Hang Seng, and China’s Shanghai Composite trading above their 10-day moving average. While this is admittedly just a measure of shorter-term momentum and could quickly fizzle out, it is encouraging that capital is finding its way into these markets despite political dysfunction (France, Germany) and lackluster economic growth (China, Euro Area) garnering headlines.
Weakness in the U.S. dollar of late has spurred greater interest in foreign markets and there is quite a bit of negative news already priced in, particularly for developed markets abroad, evidenced by the MSCI EAFE trading at 14 times trailing 12-months earnings, well below the 30-year average of 20 times. Clarity on the trade/tariff front and some signs of stability in the U.S. dollar could drive improved sentiment surrounding international markets in the coming year, and it might not take much in the way of positive news to do so amid low valuations and paltry expectations for economic growth and earnings abroad. With that said, outlining a path higher for U.S. stocks is a far easier exercise and we expect the S&P 500 to outpace foreign developed markets in the coming year as capital continues to flow into U.S. assets.
