U.S. stocks face the risk of a notable pullback over the first few weeks of the year, according to some Wall Street analysts, as markets retreat from the strongest run of back-to-back gains since the late 1990s.
Stocks failed to deliver a so-called Santa Claus Rally, a trend first identified by Yale Hirsch and the "Stock Trader's Almanac" in 1972 as broad index gains over the final five trading days of any year plus the first two of the next.
Based on the definition, the S&P 500 is down around 0.53% from its closing levels on Dec. 23, the day before the rally was to have begun. And it had fallen for five sessions, its longest losing streak since April, before posting a solid Friday gain of 1.26%.
That compares with a typical gain of around 1.3%, according to Hirsch's almanac, a tally that's around four and a half times the normal seven-day advance during any other time of the year.
Very little headline news has triggered the pullback, and the broadest measure of U.S. shares is still within 3.5% of its all-time peak and up more than 2.4% since President-elect Donald Trump's victory in early November.
The Dow has fallen around 1,500 points since President-elect Donald Trump rang the opening bell at the New York Stock Exchange on Dec. 12.Rebecca Mezistrano-TheStreet
"The Santa Claus Rally usually generates a lot of headlines due to the market’s tendency to post strong returns over this short period — or perhaps it receives more attention because it occurs during a usually slow financial news cycle," said Adam Turnquist, chief technical strategist at LPL Financial.
Stock market faces growing headwinds
Quietly, however, certain headwinds that investors and analysts have warned about are starting to accumulate.
The Labor Department's reading of weekly jobless claims showed fewer Americans filing for first-time unemployment benefits, suggesting end-of-year resilience in wages, while the ISM's benchmark survey of December manufacturing activity rose to the highest level in nine months.
Treasury bond yields are also creeping higher, with benchmark 10-year notes rising to 4.5621% in early Monday trading, while rate-sensitive 2-year notes traded at 4.328%.
Those moves reflect broader changes traders are making in their near-term Federal Reserve interest rate forecasts, with CME Group's FedWatch predicting only two reductions over the first half of 2025.
Richmond Fed President Thomas Barkin in fact told an event in Maryland Friday that he saw "more upside than downside in terms of [economic growth] as well as "more risk on the inflation side."
U.S. dollar index near two-year high
The U.S. dollar index, which tracks the greenback against a basket of six global currencies, is now trading near the highest levels in more than two years and has risen more than 7% over the past three months.
That's likely to take a toll on S&P 500 earnings as companies find it more expensive to bring overseas profits back onto their U.S.-based books.
Turnquist notes that at least based on past performance, the S&P 500 typically falls around 0.2% in a January that follows a failed Santa Claus Rally, and delivers an inferior full-year return to investors when compared with a successful one.
"As Yale Hirsch put it, 'If Santa Claus should fail to call, bears may come to Broad and Wall,'" Turnquist said.
"The S&P 500 has dipped below its 50-day moving average but remains above its longer-term uptrend," he added. "However, we believe near-term downside risk remains elevated given the recent deterioration in market breadth and momentum, stretched bullish sentiment, and macro headwinds from higher rates and a stronger dollar."
Jay Woods, chief global strategist at Freedom Capital Markets, says the early 2025 stumble could mean markets are "in the early phase of a 10% correction."
The current bull market, which began in late 2022, hasn't had a 10% pullback since October 2023, Woods said. He sees action eerily similar to that of the 2018 correction, when stocks fell 20% from their late September peak and didn't recover those price levels until the following February.
Stock market reliance on the megacaps
"The overall theme of 2024 was market rotation – which is the lifeblood of a strong and healthy bull market," Woods said. "Now we are rotating back into megacaps, but overall breadth is concerning."
He also noted that the tariffs the Trump administration has proposed have potential to keep inflation elevated, and the spending cuts and immigration restrictions it is considering could hurt job growth.
David Morrison, senior market analyst at London-based Trade Nation, however, isn't convinced the market is providing a clear signal just yet.
"It’s fair to assume that much of the recent volatility and downside pressure comes as a result of year-end window dressing and fund rebalancing, as managers shift their holdings between equities and bonds," he said.
A failed Santa Claus Rally "may put a dent in short-term sentiment, but let’s see how things go for the rest of this month, particularly once we get past Trump’s inauguration on Jan. 20," he added.
