Will investors see a Santa rally given recession warnings?

December is typically one of the best months of the year to be invested, but 2022's year-end rally could depend on the US central bank.  

A Santa rally for markets looks to be on thin ice today after global recession warnings grew louder and a City bank said a rebound for cyclical stocks had run its course.

The S&P 500 jumped almost 14% in October and November, but hopes for a further seasonal flurry of risk-on trades have so far failed to materialise in December, with popular US stocks Tesla (NASDAQ:TSLA) and Amazon (NASDAQ:AMZN) among those more than 7% cheaper.

The leading US benchmark and the tech-focused Nasdaq Composite are down 3% and 4% respectively, while the FTSE 100 index is little changed. Investors in the UK have enjoyed a strong run since mid-October, with some heavily sold stocks rebounding by as much as 70% as cyclicals in Europe outperformed defensives by 9% in the quarter to date.

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December is typically one of the best months of the year to be invested, with research by interactive investor showing that the average return in the past 36 years is 2.4% for both London’s top flight and FTSE All-Share.

And while a year-end rally is still possible, it will almost certainly be delayed until after the release of November’s US inflation print on 13 December and the conclusion of the Federal Reserve’s policy meeting the following day.

The Fed is expected to slow the pace of tightening to a half-point increase next week, but any encouragement that this represents a pivot in approach will be offset if updated projections from the central bank show a slightly higher eventual peak in rates than before.

The fears that the Fed will continue tightening even as the US economy weakens in the first part of 2023 meant the S&P closed 1.4% lower on Tuesday, its fourth consecutive decline. The mood hasn’t been helped by predictions of a US recession from the chief executives of two major US banks, including JP Morgan Chase boss Jamie Dimon.

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Brent crude futures responded to the uncertain 2023 outlook by today falling to $78 a barrel, returning the price to near where it started 2022 after a year of huge volatility.

UBS Global Wealth Management believes the outlook is confused by the two-track US economy, where manufacturing and housing are in recession and experiencing disinflation but the labour-intensive services sector is slowing very little with no inflation moderation.

Chief investment officer Mark Haefele said: “The implications are that economic growth, while slowing, is resilient and inflation is sticky, and trajectories for both are hard to predict.

“This increases uncertainty about the timing of the 2023 inflection points for growth and inflation, and that is likely to prolong market swings until those points are reached.”

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Given the prospect of periodic rallies, he favours strategies that add downside protection, while retaining upside exposure. This means support for defensive sectors and value stocks, alongside income opportunities in higher-quality and investment grade bonds.

Morgan Stanley thinks that the recent outperformance by cyclical stocks in Europe is now looking overdone relative to economic indicators and earnings trends.

In a note headed “Cyclically Exhausted” it said that some of its tactical indicators are now close to traditional sell-off territory, suggesting downside risk for cyclicals and the market alike.

It pointed out that buying cyclicals required belief in a soft landing and imminent recovery in lead economic benchmarks such as PMI figures: “Absent an imminent rebound in such indicators, cyclicals' recent outperformance looks unsustainable to us.”