Santa Claus Rally? Here’s What Needs to Happen

Updated: Federal Reserve Chairman Jerome Powell confirmed Wednesday, Nov 30, that smaller interest rate increases are likely ahead even as he sees progress in the fight against inflation as largely inadequate.

We are approaching that time of year when the stock market gets into a holiday mood triggering a Santa Claus rally into the new year. With the S&P 500 index NYSEARCA: SPY trading down (-17%) and Nasdaq NASDAQ: QQQ down a naughty (-29%) for the year, investors are left to ponder if markets have the wherewithal to stage a Santy Claus Rally. The biggest concern for the markets is rising interest rates. The U.S. Federal Reserve will have its final meeting for the year concluding on Dec. 14, 2022. They will determine the final interest rate hike and provide commentary and a question-and-answering session detailing their thoughts heading into next year. Leading up to the rate decision, there are two crucial economic reports and a slew of other factors to be aware of. Here’s what needs to happen for the Santa Claus rally to occur.

The Fed: Grinch or Santa?

Will the U.S. Federal Reserve (Fed) be a hero or villain in its final Federal Open Market Committee (FOMC) meeting of the year on Dec. 14, 2022? The October CPI report indicated that inflation was falling as headline CPI came in at 7.7% versus the 7.9% expectations. This sent markets skyrocketing higher as Wall Street figured that would be enough for the Fed to ease up on the gas pedal and slow down its rate hikes. The Fed confirmed that it is possible to slow down the rate hikes but they could go on for longer than expected. They would rather overshoot on the rate hikes and then implement rate cuts than undershoot and have inflation rise later. Markets are already expecting a slowdown to 0.25 to 0.50 rate hikes, not 0.75, to end the year at a target rate of 4% to 4.5% by year’s end. The language of the decision is also important as the market expects the Fed to even go so far as to pause interest rate hikes in early 2023. This has caused the SPY and QQQs to rally ahead of time into December. The next two key economic reports are scheduled ahead of the final FOMC meeting.

Jobs Report

The first of the two critical economic reports remaining is the U.S. Bureau of Labor Statistics (BLS) are the Employment Situation Report (aka Jobs Report) on Dec. 2, 2022. Incidentally, the October jobs report actually came in stronger at 263,000 than the 205,000 expect which indicates a still strong labor market, but unemployment ticked higher to 3.7%. The rate of job growth actually slowed down to the lowest in two years. This still should have sent markets lower, but they actually moved up on the report. The November jobs report could actually come in below expectations with the high profile lay-offs from Twitter of over 3,500 jobs, Meta Platforms NASDAQ: META of over 11,000 workers, and nearly 10,000 workers at Amazon NASDAQ: AMZN, Cisco Systems NASDAQ: CSCO of 4,000 workers, Lyft NASDAQ: LYFT of 700 workers,  and a hiring freeze from Disney NYSE: DIS.

CPI Report

The most important economic report ahead of the FOMC is the Consumer Price Index (CPI) report on Dec. 13, 2022, at 8:30 am EST, the day before the FOMC rate decision. This is the inflation gauge. The last report for October 2022 surprised the markets by coming in at 7.7% versus 7.9% expectations indicating the lowest inflation since January 2022. This was the report that prompted the rally heading into December. The next CPI report which will be a reading for the prior month November is expected to come in at 7.6%. That’s the line in the sand. If the CPI comes in under 7.6% then markets should rally higher. The magnitude of the rally depends on how far below 7.6% the number actually comes in at. On the flipside, if the CPI comes in higher than 7.6%, then markets may likely sell-off unless there is dovish language in the report.

Sell the News?

There is one more caveat to be aware of. Since the markets are forward-thinking, it often likes to anticipate an event ahead of time resulting in the opposite effect afterward. This is often coined as “Buy the Rumor, Sell the News”. If the markets expect the Fed to slow down its rate hikes due to falling inflation, as it does now, then markets may actually rally ahead of time into the FOMC meeting. If the market rallies too hard ahead of the rate decision, then it may actually sell off on the rate decision regardless. It’s prudent to give it until the next day's reaction to gauge if the market will follow through higher. Since the Fed decision is in the middle of the month, it still leaves enough time for a Santa Claus rally to occur since it usually takes place near the end of the month and year. It’s prudent to have a shopping list of stocks ready in the event it takes place this year.