Markets at Year-End: Naughty or Nice?

Where’s Santa when we need him?

You’re probably familiar with the term “Santa Claus rally.” This designation refers to the upward momentum of stocks in the last week of December and the first week of January. There are many theories as to why this calendar effect is so reliable.

Some analysts attribute the phenomenon to low trading volume, as asset managers take the week after Christmas as a holiday vacation. Others suggest the outsized buying comes from managers attempting to position themselves with increased bullish exposure as the market starts a new fiscal year.

Wall Street hates uncertainty and suddenly, as 2021 draws to a close, we’re getting a lot of it. During the final trading days of the holiday season, we may experience a Santa slump.

The unexpectedly rapid spread of COVID’s Omicron variant is spooking markets. What’s more, investors were disappointed by the failure in the 50-50 Senate of President Biden’s $1.75 trillion Build Back Better plan, which was shelved after opposition from Senator Joe Manchin (D-WV). Wall Street reacted negatively not because it likes to see Democrats get their way, but because it likes fiscal stimulus.

On Monday, the main U.S. stock market indices fell as follows: the Dow Jones Industrial Average -433.28 (-1.23%); the S&P 500 -52.62 (-1.14%); the NASDAQ -188.74 (-1.24%); and the Russell 2000 -34.06 (-1.57%). The U.S. crude oil benchmark West Texas Intermediate plunged more than 3%, as fears grew that energy demand would fall amid an Omicron-damaged economy.

However, in pre-market futures trading Tuesday, the major U.S. stock indices were sharply rebounding from their three-day slump.

The Federal Reserve’s plans to hike rates potentially three times in 2022 also is weighing on equities. After a prolonged period of dovishness, the U.S. central bank is now playing Grinch.

Watch This Video: Tougher Action From The Fed

Essentially every interest rate in the real economy tends to follow the direction of the federal funds rate. Therefore, while the Fed does not directly control the rates for important financing activity such as mortgages and small business loans, by hiking the benchmark rate, it strongly influences such costs of borrowing in the real economy.

The rock-bottom federal funds rate has been a positive for risky assets, but that’s about to change (see chart).

Red China’s red ink…

Another concern is China, which continues to grapple with the debt crisis triggered by the default of property developer China Evergrande Group (OTC: EGRNF).

As the world’s second-largest economy (on a purchasing-power basis, the biggest) and the largest trading nation (imports and exports combined), China’s well-being clearly affects all nations, particularly nations from which the Middle Kingdom imports natural resources and industrial components.

Evergrande is $300 billion in debt and struggling to make interest payments. The company’s aggressive building projects are pervasive throughout China. Evergrande’s struggles are fueling fears that China’s residential and commercial property market, which drives about a third of the country’s economy, could crash.

Beijing seeks to orchestrate a slow-motion landing of Evergrande, by restructuring its debt rather than letting it collapse or simply bailing it out. The deeply indebted real estate conglomerate still poses the risk of saddling China with a “Lehman moment.”

The debt bubble in China is one of the biggest threats facing global stability today. But investors also are casting a wary eye on an increasingly aggressive Russia, which is massing troops on the border of Ukraine and threatens to go to war with the West over control of the country.

Ukraine’s democratically elected government seeks closer ties with the NATO alliance, but Russia argues that the country is historically a part of Mother Russia and should remain that way.

Fast-spreading Omicron, potential financial contagion in China, escalating tensions in the Ukraine…a series of potential crises have emerged, just in time for the holiday. Are you looking for a trading methodology that provides big gains, regardless of mounting risks? Click here for details.

John Persinos is the editorial director of Investing Daily. To subscribe to John’s video channel, follow this link.