Jamie Spencer
As the year comes to a close, the anticipated Santa Claus rally—a phenomenon where stocks typically rise during the final days of December and early January—has failed to deliver. Instead, markets have drifted lower, with major indices like the Nasdaq 100, Dow, and S&P 500 all posting declines. This tepid performance could be a precursor to what lies ahead in 2025, as experts predict a market pullback.
Lackluster Year-End Performance
The stock market has been underwhelming in recent weeks, with the Nasdaq 100 down nearly 5% from its peak. Major tech players like Nvidia, Tesla, and Microsoft saw declines last week, and the downward trend continued into this week, with all three major indexes falling over 1% within the first hour of trading on Monday.
David Laut, chief investment officer at Abound Financial, warns of a potential market correction in the new year:
“While we are staying invested in stocks, we would not be surprised to see an early 2025 pullback of as high as 15%.”
Valuations Are Vulnerable
High stock valuations and investor optimism make the market susceptible to negative developments, according to Laut. As fear of missing out (FOMO) drives latecomers into the market, the stage is set for a potential correction triggered by bad news.
“It’s that ‘late to the party’ piece starting to set in,” Laut noted.
Events like a disappointing Nvidia earnings report, higher-than-expected inflation, or rising unemployment could act as catalysts for a sell-off. Additionally, uncertainty surrounding political policy with a new president entering the White House adds to market fragility.
The recent market reaction to the Federal Reserve’s rate cut decision illustrates how tenuous valuations have become. The S&P 500 fell 3% after the Fed announced it expects two, not four, rate cuts next year.
Historical Precedents for a Pullback
Market history provides plenty of precedent for corrections. This year alone, an 8.5% drawdown in August followed July highs, and after a strong post-pandemic rally in 2020, the market experienced a 25% decline in early 2022.
Ed Yardeni, president of Yardeni Research, echoes Laut’s sentiments, noting that high investor sentiment often signals a correction.
“When the market’s way up, catalysts from a risk-reward perspective are going to be skewed to the downside, at least in the short term,” Laut said.
Preparing for a Market Pullback
Investors should approach a potential correction as an opportunity rather than a reason to panic. Laut advises patience and warns against chasing stocks at high valuations:
“If you want to put money to work, be patient because you’re going to have an opportunity. FOMO is not your friend when it comes to investing.”
To prepare for a pullback, Laut suggests parking excess cash in short-term bond funds, which currently offer attractive yields. Examples include the SPDR Portfolio Treasury ETF (SPTB), the Vanguard Short-Term Treasury Fund (VFISX), and the Invesco Short-Term Treasury ETF (TBLL). These funds allow investors to earn returns while waiting for the market to offer better entry points.
The disappointing Santa Claus rally has left investors grappling with the possibility of an early 2025 market correction. However, by staying disciplined and focusing on fundamentals, investors can navigate the uncertainty and potentially capitalize on lower valuations. The key will be to resist emotional investing and remain patient as the market finds its footing in the new year.
