The December Stock Rally May Not Happen This Year

Investors shaken by the market's big sell-offs are hoping for a December rally to end a volatile year. This may seem like a solid bet considering that since 1950, the S&P 500 in December has risen 75% of the time, more often than any other month, according to LPL Financial. That may not happen this time. A combination of trade tensions, a potential yield-curve inversion, slowing global growth and central bank tightening create more likelihood of stock market declines than a rebound, per the Wall Street Journal.

The MSCI All Country World Index, which measures equity returns from 23 developed and 24 emerging markets, has declined just six times in December over the past three decades. This month is shaping up to be one of those outliers, with the MSCI World Index down 3.6% and the S&P 500 Index 4.6% lower for the week through Friday, marking its worst performance in roughly nine months. 

With the decade-old bull market facing major headwinds in 2018, investors seeking safety have increasingly have found fewer stock sectors - and bond sectors - to hide their money.

According to derivatives strategists at BNP Paribas, both surging volatility and the rising correlation between different investments have resulted in quantitative strategies exacerbating sell-offs. 

Further, rate hikes by the Fed - and the prospect of more to come - are squeezing corporate margins, earnings growth and reining in stocks.

On the bright side, market bulls say a sudden deal between President Donald Trump and Chinese President Xi Jinping could cause a huge year-end rebound. The S&P 500 rallied earlier this month on news that the U.S. and China had agreed to a 90-day trade truce, postponing Washington's plans to impose more tariffs . 

In terms of higher interest rates, the Wall Street Journal reported last week that the Federal Reserve was considering whether to signal a new wait-and-see approach at their meeting later in December, which could result in a slower pace of interest rate hikes in 2019. Stocks initially pared sharp declines on the report.

Meanwhile, investors may be overreacting to messages from the bond market. Flatter yield curves, on the verge of a yield curve inversion, are spooking many investors who fear this is flagging a recession. “The signal from the yield curve is not what the textbook would suggest,” says Allianz chief economic advisor Mohamed El-Erian, per the Journal..

El-Erian noted that distortions caused by years of unprecedented central-bank stimulus are making signals look worse than they are. He noted that “it’s very hard to get a recession” with “wage growth percolating, business investment increasing and government spending rising.”

Canaccord Genuity's Tony Dwyer echoed the more positive sentiment, applauding the combination of a trade breakthrough and a dovish speech delivered by Fed Chairman Jerome Powell, as cited by MarketWatch. 

He added that three downside drivers of the market correction earlier in 2018, including fears that the Democrats would win both the House and the Senate in the midterm, worsening trade wars and a hawkish fed, have all been partially resolved.

That doesn't mean it's clear sailing in the equity markets. El-Erian has warned investors against buying on the market dips because stocks may not rebound. “In the old days, you would buy every dip,” Mr. El-Erian said. “Now it’s the other way around. People are using rallies to reduce risk and they’re not buying dips. That’s a fundamental change.”