Santa rally sputters as pendulum-like markets settle on a loss for the week

MANHATTAN (CN) — Wall Street’s great foe for the past year, inflation, seems to have been tamed, but a new enemy has taken its place: fear of recession.

By the closing bell on Friday, the Dow Jones Industrial Average had gained about 284 points, while the S&P 500 and Nasdaq declined 8 points and 284 points, respectively. A raft of economic data this week had both good and bad news for investors, but they all support the idea that the Federal Reserve will not back away quickly enough from its hawkish approach to interest rates to stave off a contracting U.S. economy.

On Friday, encouraging news regarding inflation managed only to staunch the bleeding. According to the Bureau of Economic Analysis, core inflation decreased to 4.7% in November compared with a year ago. The overall number is good, but markets remain concerned about a hot economy, spurring the Fed to keep interest rates coming.

“At this point the market has been backed into a corner, since more robust spending and higher growth is indirectly bad for the stock market,” said Chris Zaccarelli, chief investment officer at the Independent Advisor Alliance. Slower spending and growth also would be bad for the market, he said, because it implies lower company earnings.

“It’s not too late for the Santa Claus rally — typically defined as the last five days of the year and the first two days of the following year — but unfortunately the positive inflation data … has been overshadowed by the Fed’s tough language and the upcoming recession that they’ve orchestrated with their aggressive rate hikes,” Zaccarelli said.

Midweek, investors were given a brief reprieve from the carnage. On Wednesday, the Conference Board’s consumer confidence index showed increasing assurance in the U.S. economy, rising sharply from 101.4 to 108.3, well above what the consensus had forecast. The December index reversed declines from the two previous months to reach its highest level since April.

Consumers’ appraisal of both business conditions and the labor market improved month-over-month, according to the index; 19% of consumers assessed the economy as “good” from 17.8% last month, while 47.8% of consumers said jobs were “plentiful” compared with 45.2% in November. But the index also showed a shift in consumer spending.

“Vacation intentions improved but plans to purchase homes and big-ticket appliances cooled further,” Lynn Franco, senior director of economic indicators at the Conference Board, said in a statement. “This shift in consumers’ preferences from big-ticket items to services will continue in 2023, as will headwinds from inflation and interest rate hikes.”

The index — as well as positive earnings from Nike and FedEx — helped spur markets higher on Wednesday, with the Dow closing 527 points higher. “Markets are too pessimistic and not paying attention to what’s actually happening in the economy,” Jamie Cox, managing partner at Harris Financial Group, said about the short-lived rally on Wednesday. “Earnings are dropping as expected, but not to the extremes markets are pricing.”

The Conference Board also released bad news for investors on Thursday, however, with its leading economic index falling for the ninth straight month after peaking in February. The fall was driven mostly by a fall in building permits and jobless claims, but underneath all that, according to the board, was mostly the Federal Reserve’s monetary tightening. “As a result [of interest rates curtailing economic activity], we project a U.S. recession is likely to start around the beginning of 2023 and last through mid-year,” said Ataman Ozyildirim, senior director of economics at the board.

Other metrics this week showed a still-resilient economy but one that has started to contract. The U.S. Bureau of Economic Analysis on Thursday revised its gross domestic product for the third quarter so that it was actually higher than originally reported. Instead of the 2.6% increase in originally reported back in October, it turns out the economy actually grew by 3.2% during the third quarter.

Earlier in the week, investors were dismayed, though perhaps not entirely surprised, by data showing existing home sales fell by 7.7% from October and more than one-third since last year, tumbling back to 2010 levels.

Homebuilder sentiment also fell for the 12th straight month, according to the National Association of Home Builders, and at 31 it sits now just 1 point above its lowest level back at the start of the pandemic. Despite the poor showing, NAHB officials noted the drop in November was the smallest decline in the past six months, hinting at a bottom for builder sentiment.

The index, which was worse than anticipated, was blamed mostly on high mortgage rates caused by interest rate hikes. While winter is typically a slowdown for home building, this winter is particularly bad, experts say. “Surging interest rates, terrible affordability, and recession fears are big headwinds to the housing market, and they don’t look like they will let up anytime soon,” Bill Adams, chief economist at Comerica Bank, said.

Follow @NickRummell

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