By Teresa Rivas

It's the season to be jolly -- but investors should still be prepared to eventually face some postholiday blues.

The S&P 500 was edging higher on the first trading day of December after a fantastic performance in November. And it looks like the stage is set for a Santa rally through the end of 2024 -- years that start as strongly as 2024 did in the first quarter and the first half almost always end well.

Likewise, as LPL Financial Chief Technical Strategist Adam Turnquist notes, the S&P 500 has notched an average gain of 1.6% in December since 1950 and finished the month higher 74% of the time "marking the highest positivity rate across the calendar." Still, it could take some time to see that pattern kick in, as those tend to be clustered in the back half of the month.

"Historically, the S&P 500 has traded near the flatline during the first half, with upward momentum building around the 11th trading day of the month," Turnquist wrote.

That said, January could be a different story. The bull market may be nowhere near finished, but a pause from Inauguration Day onward might be in the cards, given that the postelection euphoria will give way to actual policy implementation, which might not go the way investors hope.

That is certainly the case when it comes to tariffs. So far the market has been largely ignoring their potential impact, as it "simply... doesn't believe Trump will follow through with them," to quote Sevens Report President Tom Essaye.

Yet if they do become a reality, "Investors and consumers can expect upward price pressure from recently announced tariff proposals," writes Silvercrest Asset Management Chief Investment Strategist Robert Teeter. Although the details are still guesswork by necessity, "new government policies [could] reboot 2025 inflation--just as post-pandemic inflation is poised to run its course."

He estimates a possible 0.5% increase in domestic prices, while noting other strategists have warned that figure could be as high as 1.5%.

In fact, while strategists have been busy proposing reasons why president-elect Trump won't impose the tariffs he has been promising to impose all along, at the very least it is "obvious that at some point in this process we might get a scare or two that Trump is actually serious, " argues 22V Research's Gerard MacDonell.

That is troubling given that low inflation for goods -- a figure that is looking much better than the services side, which seems to have settled above the Federal Reserve's 2% target -- would "definitely not survive the imposition of tariffs even 1/4 as large as what Trump has most recently been proposing, including the 25% level Trump wants to slap on Canada (I mean Americans buying Canadian products)," he writes.

Upward pressure on inflation would of course limit the Fed's ability to lower interest rates. It could also disrupt the overwhelmingly positive narrative.

That is setting off warning bells for The Bear Traps' Larry McDonald, given the consensus appears so unanimously bullish.

"We are taking down exposure to equities, especially high beta names. Investors are in a pollyannish trance, pricing in a linear price trajectory for the Trump agenda. While we see the upside, there is a rocky road ahead of the sunshine," he writes. "Investors have never been more bullish across the sentiment surveys, and Wall St. strategists -- after projecting just a 1% return for stocks a year ago, are juicing their 2025 targets...This is the largest surge in strategist optimism on record."

That does sound concerning, but perhaps calls for caution more than pessimism.

With the S&P 500 trading at 22 times forward earnings it looks expensive on a historical basis, and means investors have to look to profit growth rather than multiple expansion to push the market higher, notes Humble Student of the Markets' Cam Hui.

"The U.S. market is facing a number of 'this will not end well' valuation-based warnings. However, I see no immediate bearish triggers that warrant defensive portfolio positioning. I am therefore expecting S&P 500 returns to be roughly flat or in the low single-digits for 2025," Hui wrote.

That might sound disappointing when compared with this year's more than 26% rally, but then the last two years have spoiled investors. A relatively modest 2025 return would be in keeping with historical precedent, as bull markets tend to slow in their third year, and more reflective of the complex path forward for stocks. And a small gain is better than no gain.

Write to Teresa Rivas at teresa.rivas@barrons.com

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December 02, 2024 13:07 ET (18:07 GMT)

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