A December rally may arrive, but the first half of 2023 could be rough for stocks

Stock strategists say there’s a good chance for a Santa Claus rally next month, but the market may not be handing out many gifts to investors in the first part of next year. Some strategists see a bottoming for stocks in the first part of 2023, but others say the key indexes could avoid breaking down to a new low but remain volatile. The S & P 500 rose back above 4,000 Tuesday and was holding above that level on Wednesday. Its recent intraday low of 3,491.58 was set on Oct. 13. “Most strategists are calling for 4,100, 4,150. But they’re also calling for new lows in the first quarter,” said Scott Redler, chief strategic officer of T3Live.com. Redler follows short-term technicals, and he said the market could run into weakness around earnings in the first quarter, after a fourth-quarter Santa rally. “I think the Fed does stop raising rates in the first quarter, but it has to leave them there for an entire year. That’s why the next year could be so bad for stocks,” he said. The Federal Reserve is expected to raise its fed funds target rate by a half point in December and increase it again until it reaches 5%. “Until things break, they have to keep it up there,” said Redler. He said one thing that could break, would be if there was a big stock market sell-off that would concern the central bank. The fed funds rate range is currently 3.75% to 4%. Recession warning? Sam Stovall, chief investment strategist at CFRA Research, said there is a high level of uncertainty about whether a recession is coming in the first part of 2023. For that reason, the outlook for stocks is also unclear. “I don’t know. That’s the concern that I have,” he said. “I think the Fed is going to be ending its rate-tightening policy fairly soon … in the first quarter of next year. I think the Fed might end up lowering rates by the end of the year. But with the yield spread being as wide as it is, it makes you say a recession is coming, and I question whether the market is predicting correctly a recession.” Stovall was referring to the steep inversion of the Treasury yield curve, meaning that short-end rates, like the 2-year Treasury yield, are well above the longer term, like the 10-year. That is viewed as a recession warning. With the 10-year at about 3.73% Wednesday, that so-called inversion was more than 75 basis points. A basis point equals 0.01 of a percentage point. Bank of America strategists cite that inversion, and expectations for a mild recession next year, as a reason behind their negative call on stocks for the first half. “We stay bearish risk assets in H1, likely turn bullish H2; market narrative to shift from Inflation and rates ‘shocks’ of ’22 to recession and credit ‘shocks’ in H1 ’23,” they wrote in a note. Following that, they expect the bullish peaks of inflation, fed funds, bond yields and the dollar to take hold in the second half and potentially trigger a new bull market. Finding a strategy to survive Stovall said the earnings outlook is already negative. He said analysts forecast a decline in S & P 500 earnings for the fourth quarter, followed by more choppy weakness in the first half and then higher growth in the second half. I/B/E/S data for Refinitiv has a forecast of a 0.4% fourth-quarter decline in S & P 500 earnings. “We’re concerned in terms of earnings, but it’s not like the double-digit declines we saw in 2020 or ’08 when it was down 32% year over year,” Stovall said. Stovall said there has been no big selling crescendo in the current bear market. “We did not get the capitulation we normally get in bear markets. However, we could sidestep that capitulation if this bear market is only 25%,” he said. “If it ends up being deeper, we will get that capitulation.” Stovall said investors need to find a strategy to weather the first half. Dollar-cost averaging, for instance, involves investing a set amount of money in regular intervals over time, regardless of prices. “Because the first half is so uncertain, it’s probably a better period to dollar-cost average in. A dollar-cost average first half with an expected recovery in the second half,” he said.