What History Says About December Returns

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What History Says About December Returns

US equities are off to a much choppier start in December than is typical for this month. So, for today’s “Data” section, we’ll look back in history to see what it can tell us about potential S&P 500 price action for the rest of this month and 2021. We will focus on returns since 1980 because it’s a long enough period to give us a useful dataset and is what we often call the “modern” US equity market.

We have three points to this analysis today:

#1: The S&P 500 usually shows a positive return in December:

  • The S&P has been up an average of 1.3 percent in December since 1980.
  • The standard deviation of December returns is 3.5 points.
  • The S&P has performed positively three-quarters (73 pct, to be precise) of the time in December.
  • It has performed greater than one standard deviation above the average in 6 years, and worse than one standard deviation below the average in 5 years.

Takeaway: It’s unusual for the S&P to produce a negative return during December. It’s only happened about a quarter (27 pct) of the time since 1980, down an average of 2.8 pct. That average is skewed lower by a few outlier years, such as: a Fed policy mistake in 2018 (-9.2 pct), the lead up to the second Gulf War in 2002 (-6.0 pct) and the early 1980’s bear market in 1981 (-3.0 pct).By contrast, the S&P has been up an average of 2.8 pct during positive December years. The best year was +11.2 pct in 1991 and the weakest positive return was 41 bps in 2000.

#2: During the rare times that the S&P performed negatively in December, it was either due to a macro/geopolitical-related issue or after already strong year-to-date returns. Here are the December returns for the 11 years when the S&P has been down in that month since 1980 and their corresponding reasons why:

Macro or geopolitical-related issues:

  • 1981 (S&P down 3.0 pct in December): Bear market
  • 2002: (-6.0 pct): Lead up to Gulf War II
  • 2005 (-0.1 pct): Concerns about an economic slowdown
  • 2007 (-0.9 pct): First month of Great Recession
  • 2015 (-1.8 pct): Confluence of issues this year (i.e. falling oil prices, Chinese economic slowdown, first Fed rate hike in almost a decade)
  • 2018 (-9.2 pct): Fourth Fed rate hike that year with hawkish communication

Negative December performance in years with above-average total annual returns:

  • 1980 (-3.4 pct in December): +31.7 pct total annual return
  • 1983 (-0.9 pct in Dec): +22.3 pct for the year
  • 1986 (-2.8 pct in Dec): +18.5 pct for the year
  • 1996 (-2.2 pct in Dec): +22.7 pct for the year
  • 2014 (-0.4 pct in Dec): +13.5 pct for the year
  • Average total return: +21.7 pct

Takeaway: years with negative returns in December are split into two camps: either 1) they were related to wars, economic slowdowns, or a Fed policy mistake, or 2) the market was taking a breather at the end of the year after a big run-up.

#3: This December has a combination of the warning signs above:

  • Strong Jan-Nov returns: The S&P was already up a very strong 22 percent year-to-date heading into the last month of this year.
  • Fed setting up future rate hikes: The datapoint that stuck out to us in this analysis was December 2018’s down 9.2 pct return. Chair Powell raised near-term rates for the fourth time that year, despite economic uncertainty about a slowing US/global economy. The market had a sharp selloff and he later had to walk back his communications to a more dovish tone.

    The Fed’s upcoming December 14-15 meeting should also set the tenor for future rate hikes, as Chair Powell already signaled that’s when the FOMC will consider speeding up tapering its bond buying. The obvious reason (at least to us): so the FOMC can more quickly get to raising near-term rates to dampen inflation.
  • Uncertainty: Investors are left with a lot of uncertainty as it relates to the economy heading into 2022. Not only do they have to consider the pace of Fed rate hikes, but also the impact of the new virus variant which will likely slow down progress in the labor market and supply chain. These latter factors put upward pressure on inflation, leaving the Fed trying to get that under control through rate hikes without causing a recession in 2022.

Bottom line: while December is usually a positive month for US equities, it will likely prove much more volatile this year given the overhangs of 1) an already strong year for returns, 2) the potential for a Fed policy mistake, and 3) uncertainty about the new virus variant’s impact on the economy. We’re still positive on US equities because we think this setup will likely cause the market to continue underestimating US corporate earnings, which we think will remain strong especially with their growing pricing power and robust consumer demand. We do not expect a smooth ride higher, however, given the factors we outlined today.