Market turbulence may be a theme in the holiday week as investors fret over omicron, the Fed

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Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, December 8, 2021.

Brendan McDermid | Reuters

Stocks could be volatile in the coming week, with thin volume exaggerating moves in both directions ahead of the Christmas holiday.

The market was whipsawed in the past week, with the Nasdaq down about 2.9% since Monday and lagging the other major averages on a weekly basis. Technology stocks were at the center of major market swings, as investors reacted to the spreading omicron Covid variant and the Federal Reserve’s hawkish shift.

“As we head into the last two weeks of the year, we know volume is light and volatility can also pick up,” said Jeff Kleintop, chief global investment strategist at Charles Schwab. “There’s the possibility of a Santa rally, but there’s also the possibility that the lack of volume can lead to dramatic swings to the downside as well.”

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While December is typically positive for stocks, the traditional Santa Claus rally is the historically positive market performance that often comes in the last five trading days of the year and first two of January, according to Stock Trader’s Almanac. As the saying goes, if Santa doesn’t call, bears may come to Broad and Wall — the street address of the New York Stock Exchange.

A thinner market near the end of the year

So far, the S&P 500 is still up 1.2% for December, but it’s down nearly 1.9% for the week. The broad-market index has a roughly 23% gain for the year. The index ended Friday at 4,620.

“The Santa Claus rally this year is a little tough to call because the market has done so well up to this point. Building on that momentum is a bold call,” said Michael Arone, chief investment strategist at State Street Global Advisors. “Volumes are going to decrease, and that’s likely to lead to greater volatility into year end. It wouldn’t surprise me if markets close the year strongly, but with the omicron variant and the Fed tightening, it just seems anxiety is at high levels.”

Strategists haven’t given up on the idea of a late December to early January rally. However, with the selling pressure, it could be more difficult for the seasonal year-end buyers to boost the market. The thinness of the market may also make it tricky to gauge how stocks will trade into January.

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“I think it’s going to be hard to get a real tell on the market — the light volume and the fact there’s going to be relatively little economic news or corporate news. It’s going to be just incremental news on omicron,” said Kleintop.

He said earnings in the past year have been a catalyst for stocks, with companies beating estimates and raising guidance. That could turn the tide in the next earnings season in mid-January, if stocks continue to move lower.

“This time we might get a lot of dividend increases. There’s a lot of cash out there,” he said. Kleintop said expectations are for just an 8% gain in corporate profits in 2022, and that could move higher since companies appear to be managing margins better than expected.

In the week ahead, there are several economic releases to watch. The markets will be most fixated on personal consumption expenditures next Thursday, as the so-called PCE deflator is the inflation data most watched by the Federal Reserve. The report follows November’s hot consumer price index, which was up 6.8% on a year-over-year basis.

Arone said the market will also monitor the consumer confidence index release next Wednesday for inflation expectations. The University of Michigan’s consumer sentiment index is out Thursday.

Key real estate indicators are also out next week, with existing home sales on Wednesday and new home sales Thursday. Durable goods are also out Thursday.

The market is closed for the Christmas holiday on Friday.

Bond market confusion

As stocks gyrated, bond yields went down in the past week, especially after the Fed announced Dec. 15 that it would speed up the end of its bond-buying. The central bank also provided a new interest rate forecast which showed members expect as many as three hikes next year, when previously they did not forecast any.

The Fed also removed the description of inflation as “transitory” from its statement.

Bond yields move opposite price, so the move lower in rates was surprising to market professionals. It would be logical to have expected a jump in yields at the shorter end of the market, which is most influenced by Fed policy. For instance, the 2-year Treasury yield was at 0.63% Friday afternoon, below the 0.67% level it was at ahead of the Fed news.

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The benchmark 10-year yield was at 1.44% before the Fed’s announcement. It had fallen to 1.37% by Friday morning and was at around 1.40% in afternoon trading.

Yields initially inched higher Friday afternoon after Fed Governor Christopher Waller said the central bank could raise interest rates as early as March. Goldman Sachs economists had been expecting a March hike, but most expected the Fed to wait until May or June because it will end its bond program in March.

“I do think the omicron scare has got people spooked. On the long end, it’s weighing on it,” said Wells Fargo’s Michael Schumacher. “The front end doesn’t make a lot of sense. We just heard from the Fed… The front end should really be taking its marching orders from Powell.”

China easing?

While the Fed and the Bank of England have recently moved to tighten policy, another economic superpower may be doing the opposite.

Schumacher and Kleintop said a positive surprise for markets could come from China ahead of Monday’s trading.

“On Monday, we’ll all be watching China with what they do with their loan prime rate. There’s a chance they could cut it,” Kleintop said.

“If China is going to re-inflate their economy, that would be a real boost to global growth,” he said.

What to do

Kleintop said investors should stay fully invested. He noted that because of the big rotations in market leadership this year, investors should be more diversified.

“Every time we started to see a breakout with value, it was crushed with another virus outbreak. We should be seeing growth stocks outperform here, as cases rise, but they haven’t made a new high relative to value since the news of omicron,” said Kleintop.

Kleintop noted that the tech sector is highly valued, with its price-earnings ratios 10 points above the 20-year average. The forward price-earnings for global tech was 28.5 Friday. He said that compares to the global energy sector, trading on a 12-month forward price-earnings ratio of 9.5, about nine points below its average.

“This is the widest gap we’ve seen between the growthiest of the growth and the value sectors,” Kleintop said. “We haven’t seen tech make a new high relative to energy since before omicron. Certainly, there’s the Fed weighing on valuations as well as there’s the idea there’s going to be less liquidity pouring into these favorite stocks.”

Kleintop said he does not see a big gain for the market in 2022, like this year, and investors should look abroad for some better gains.

“We see a positive year for equities but nothing like this year,” he said. “There’s a potential outperformance by Europe and international next year, after they underperformed.”