A Clear Path to a Santa Rally
I stated last week there was likely one remaining hurdle for a Santa rally last week and the market largely cleared it, as economic data was consistently Goldilocks and left the Fed likely to cut rates next week, while earnings results and management commentary were broadly positive.
As a result, stocks extended the 2024 gains. The major economic reports from last week (which are the last ones for 2024) were a perfect representation of data in 2024, i.e., showing solid economic activity but also allowing the Fed plenty of space to cut rates. The ISM Manufacturing PMI, which has been below 50 all year, rose close to 50 and implied the manufacturing sector isn’t dramatically contracting. The Service PMI, which was border line too hot, pulled back to just above 50, removing concerns the economy was reheating.
The jobs report, meanwhile, was Goldilocks, especially if you look at October and November combined (about 150k job adds each month). Meanwhile, Fed commentary reiterated the commitment to bringing rates lower over time and did nothing to push back against market expectations for a cut next week. Finally, earnings from tech companies and consumer companies implied continued solid results.
In sum, the last big week of 2024 was a perfect snapshot of the factors that have legitimately driven the S&P 500 above 6,000: Solid growth, falling rates, stable earnings. In the short term, last week’s data continued to pave the road for a continued Santa rally that could see the S&P 500 move higher into year-end.
But this optimistic set up has, as usual, been taken to limits by investors. The S&P 500 is trading at extremely rich valuations (about 22X forward earnings depending on what 2025 S&P 500 EPS you’re using, but most put it between $270-$278/share) and while that won’t directly cause a selloff, it means there is a large “trap door” on this market we need to be aware of should we encounter legitimate disappointment early in 2025.
And there will be candidates for disappointment in the new year, with most of them centering around potential policy disappointment in January (the pushback against some of Trump nominees is showing resistance from traditional Washington and while the market is embracing that now, the opinion could change if it results in lack of progress on tax cuts or a budget).
Tariff threats, meanwhile, require no congressional approval, as we know, so they are likely to come potentially fast and furious once Trump takes office January 20.The outlook for stocks over the medium and longer term remains broadly positive because growth is solid, rates are falling, earnings are stable and geopolitical risks exist but aren’t big enough to overcome the positives.
The path to a continued rally into year-end is clear, but at the same time we should all be prepared for 2025 to start with some volatility around headlines from potential policy disappointment, a possibly slightly slower pace of rate cuts in 2025, and geopolitical saber rattling and/or tariff threats.
However, as long as growth remains solid, the Fed is cutting rates and earnings/corporate commentary are both positive, those potential problems are relatively minor and any immediate and temporary volatility that comes from them should be viewed as a bump along the road in a still-upward-trending market (and, likely, a potential entry point for those not already in).
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