Now that the Federal Reserve (Fed) has finally moved the market beyond the discussion of when the initial rate hike will take place with their increase of the Federal Funds Target Rate by 25 Basis Points (0.25%) yesterday, I believe that the stock market will likely move higher over the course of the last couple of weeks of 2015 (though perhaps more muted and not as high as many investors would like) consistent with what is often referred to as a “Santa Claus Rally.” A Santa Claus Rally is an often cited stock market occurrence where positive stock market returns are realized over the last five trading days of the current year and the first two trading days of the New Year. According to the 2015 Stock Trader’s Almanac, a Santa Claus Rally has yielded positive returns in 34 of the past 44 holiday seasons going back to 1969. As a result, such a positive finish in 2015 would not be without historical precedent. Our belief is centered on the following:
- A positive confirmation from the Federal Reserve that they now feel confident that the U.S. economy is on stable enough ground to withstand the beginning stage of what I believe will be a gradual and protracted period of rising interest rates. This is important as many (including yours truly) were becoming concerned that the Fed may themselves be more concerned with future global economic growth potential and its impact on the impish U.S. economic recovery than they were previously communicating following the Fed’s “no-action” decision in September.
- A move away from Fed speculation and a return to market and economic fundamentals, both of which appear to be relatively positive in the U.S. Further evidence of a solidifying, though certainly not blockbuster, U.S. economy can be found this morning in Jobless Claims data, which showed a drop of 11,000 initial claims being filed during the week of December 6 – December 12. This does not suggest that improvements still do not need to be witnessed on the wages front but does speak generally to an improving jobs market, recognizing that the current labor force participation rate remains as an overarching concern.
- A generally positive U.S. consumer as evidenced by the University of Michigan Preliminary Consumer Sentiment reading of 91.8 for the month of December. This figure was slightly higher than the 91.3 reading in November, which suggests to us that consumers are viewing current economic conditions more positively – though this may not necessarily be the case looking over the longer term. Consumer sentiment is a critical data point as 70% of Gross Domestic Product (GDP) in the U.S. currently comes from consumer spending. According to data provided in a December 11, 2015 article from Doug Short which appeared on Advisor Perspectives, the University of Michigan Consumer Sentiment reading has averaged 85.3 since its inception in 1978. During non-recessionary years the average reading is 87.5. Conversely, the average reading during recessionary years is 69.3. As a result, the current reading is 5% above the non-recessionary average and 32% above the recessionary average.
The likelihood of a Santa Claus Rally to close out the year does not mean that the days of volatility are behind us as we move into the New Year – or even for the balance of 2015. To the contrary, I contend that investors will be challenged to find pockets of risk-adjusted return opportunities in 2016. Accordingly, investors should start to position themselves for what will likely be a volatile environment for stocks in 2016 as market participants digest a variety of factors, including, but not limited to; the outcome of the Fed’s eight scheduled meetings in 2016, oil prices, economic growth reports coming out of the likes of the eurozone and China and, not to be forgotten, the race for the next president of the United States.
Looking beyond just 2016, we, at Hennion & Walsh, also believe that it is worthwhile for investors to consider areas of the market (both in terms of asset classes as well as sectors) that have historically performed well, on a relative basis, during previous periods of gradual and extended periods of Fed tightening. One such period to analyze would be the time frame of 2004-2006, when the Fed raised interest rates in 25 Basis Point increments on 17 different occasions.