Optimism Driven by Fed Signals and Moderate Inflation
Data from the Stock Trader’s Almanac going back to 1969 indicates that, on average, the S&P 500 has gained 1.3% during the last five days of December and the first two days of January. The gains during this period have been attributed to various factors, ranging from year-end buying following tax-related sales to general optimism associated with the holiday season.
This year, the optimism is particularly high due to the Federal Reserve’s surprising announcement earlier in December. The central bank signaled that its historical monetary policy tightening is likely over and projected rate cuts into 2024, given indications of ongoing moderation in inflation. Recent data supports this trend, with the personal consumption expenditures (PCE) price index showing a further slowdown in U.S. inflation in November, falling below 3%.
“The narrative will continue to be about the Fed making a dovish pivot,” says Angelo Kourkafas, senior investment strategist at Edward Jones. According to a report by BofA Global Research, Bank of America clients purchased a net $6.4 billion of U.S. equities in the latest week, marking the largest weekly net inflow since October 2022.
Retail Investor Demand and Recommendations by Research Firms
Vanda Research notes a “sharp increase” in buying activity among retail investors over the past four to six weeks. The firm explains that individuals have redirected their purchases toward riskier securities after aggressively pursuing higher yields in recent months. Furthermore, Ned Davis Research recommends that investors allocate an additional 5% from cash to equities based on indicators that measure stock market breadth, bringing its equity allocation up to its maximum amount in portfolio models.
However, it is important to note that trading volumes are expected to be thin for the rest of the year as many investors take holiday breaks. This leaves stocks particularly sensitive to unexpected news or large trades, as demonstrated earlier this week when the S&P 500 unexpectedly turned lower and closed down 1.5% on Wednesday. Market participants attribute this move to factors such as low volumes, activity in zero-day options, and trades by institutional investors, following an extended period of stock market gains.
Looking ahead, Kevin Mahn, president and chief investment officer at Hennion & Walsh Asset Management, suggests that investors heavily invested in cash may seek to enter the market next week due to the fear of missing out on the ongoing equity rally, commonly referred to as “FOMO.” Mahn expresses a cautious view, stating, “I think the markets have gotten a little ahead of themselves based upon the extent of the rally so far.”