Market May Not See Santa Rally After More Losses

Will this be the year of no Santa Rally?

Another day of losses blanketed the stock market to start what may be the third down week in a row across the indexes.

The market is sending signals that one Simpler Trading team member calls a “very dangerous technical picture” for traders hoping for positive movement in the stock market.

Fed actions send stock market into ‘danger’ zone

Last week the final Federal Open Market Committee (FOMC) meeting of the year was the catalyst that sent the stock market reeling.

The FOMC, or central bank, hiked benchmark interest rates another 50 basis points, or .50%, on Wednesday.

This pushed the federal funds rate to a range of 4.25% to 4.5%. This is the highest funds rate in 15 years, and the rate was just above zero in March. This was the seventh interest rate hike this year from the FOMC, including .75% rate hikes in a row.

The three major indexes have finished in the red for three days in a row following the Fed actions, which Federal Reserve Chairman Jerome Powell plans to continue through 2023.

“Powell continues to signal a more hawkish stance than the market wants,” said Sam Shames, Vice President of Options at Simpler Trading. “This is likely to continue until we start to see a material uptick, likely next year, in unemployment.

“It is very difficult to squash inflation at 7%+ with a funds rate below the inflation rate,” Sam said. “It is also difficult to squash inflation with a tight and strong labor market.”

“Listening to the speech, I did not hear any hints of a reversal, so all this pivot talk makes no sense for now and is likely wishful thinking by traders stuck in long positions,” Sam said.

“If we focus on the SPDR S&P 500 ETF Trust (SPY), now we can see three countertrend rallies all of which ended with lower highs,” Sam said, noting market reaction over recent sessions. “The reason the number three is important is because bear markets tend to have three countertrend rallies before the ‘cathartic puke’ phase.”

Heading into the end of the year, the stock market is acting queasy, and Sam sees this as a “very dangerous technical picture.”

“The technicals are not good here and this week starts with almost everything giving significant sell signals on multiple timeframes all at once,” Sam said.

In the market today, the Dow closed at 32,757.54 points to fall .49% (dropping 162.92 points on the day). The Nasdaq dropped to 10,546.03 points for a 1.49% tumble while the S&P 500 slipped by .90% to 3,817.66 points.

“Probabilities favor the bears here, but as always, we must understand the other side of risk,” Sam said. “How can the bulls get out of this box?”

“Bulls are at a level where they must short squeeze or die,” Sam said. “This is not the expectation as the probabilities highly favor new lows, but it’s the only way out for bulls. It will be very difficult to grind here, so bulls must find a catalyst and blast.”

Few potential catalysts are on the calendar through the end of the year.

Economic news events, or potential catalysts, are light this week and next week the Christmas holiday is celebrated on Monday with the stock market closed.

Events ahead include: the U.S. Consumer Confidence Index (CCI) on Wednesday; initial and continued jobless claims on Thursday; and the Personal Consumption Expenditures (PCE) Price Index and University of Michigan (UMich) Consumer Sentiment Index on Friday.

Bulls will have to seize any short squeeze opportunity to rally into the New year.

“Again, a short squeeze is the much lower probability,” Sam said. “The much higher probability is that the weight of the technical sell signals takes the market lower.”

Weakness in big names could weigh on the stock market and push it further down.

“This will likely be led by mega cap tech stocks as companies like AMZN, TSLA, GOOGL, and AAPL all collectively have large air pockets under support and squeezes,” Sam said.

Market fear shifts from inflation to recession

Recent Fed actions have impacted the stock market and retail traders will need to adjust trading plans to be ready for the fallout.

“Last week’s pullback in the markets occurred amid increased fears of a slowdown in the economy following the Federal Reserve’s announcement of a higher than expected interest rate hike for a more prolonged period,” said Mary Ellen McGonagle, Senior Managing Director of Equities at Simpler Trading.

Fear in the marketplace appears to be shifting from inflation panic to weighing the recession impact next year.

“The result was a decline in areas that will be most negatively impacted by any economic slowdown, while bright spots such as the biotech sector and more defensive staples, utilities and healthcare fell less than the markets,” Mary Ellen said. 

One classic safety outlet is coming back into play in this shift.

“Gold stocks also outperformed after closing the week flat,” Mary Ellen said. “Historically, this safe haven asset can outperform during recessionary periods, particularly if the U.S. dollar remains relatively low as it has been.”

Traders must stay on top of any shifts in the market through the holiday season.

“Overall, price action last week was not positive and at this time we would not put new money to work,” said Mary Ellen. “Should we see a resumption of the recent bear market rally with a move above key moving averages for the major indexes, any new positions would need to have a short-term horizon.”

Hopes dim for bullish bounce into Santa Rally 

Historically December is generally bullish as the Santa Rally approaches, building enthusiasm in the stock market.

This end of year bounce is typically the last five trading days of December and the first two trading days in January. Buying activity tends to pick up across the market during this festive phase where people feel more optimistic about the future.

With hawkish Fed plans, the economy facing a recession, and market participants protecting capital, Santa may be sitting out this trading season by next week.

Instead of a Santa Rally this year retail traders may have to take their lumps as the market continues to bleed red.