As Sam Sees It: What December Means for the Market in 2016

Sam Stovall  |

Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market. 

EQ: After a bit of turbulence in November, it seems the market may be back on track to close in the green. What’s the sentiment that you’re getting from the market right now as we head into the final stretch?

Stovall: It’s interesting because I’m getting mixed messages in terms of sentiment from the market versus sentiment from investors. Investors that I speak with are constantly referring to the elevated wall of worry and wondering why the market is not retesting the lows that we saw in late August. On the other hand, the market action itself, I think, is encouraging and points to positive December along with the traditional Santa Claus rally. So I would not be surprised if we get back to and exceed the all-time high set on May21 of this year at the 2131 level in the S&P 500.

EQ: If for some reason we don’t end up getting a Santa Claus rally because of the elevated wall of worry, we are looking at the possibility of a relatively flat year for the market. What kind of implications could that have for 2016 expectations for the S&P 500?

Stovall: There’s an old saying that I remember reading in the Stock Traders’ Almanac that says, “If Santa Claus should fail to call, the bear will come to Broad and Wall.” So if we don’t have a good end-of-year thrust, then the implication is investors are nervous buying into stocks for the coming 12-month period, which could imply something worse along the way.

That said, stock market history is encouraging in that usually positive performances follow flat performances. Since World War II, there have been 10 times that the calendar-year performance for the S&P 500 was a gain or loss of 3% or less. In the subsequent year, the S&P 500 rose an average of near 13% and advanced in price in eight of 10 observations. So really, the only decline of any merit was a 14% decline in 1957, which was the tail end of that two-year bear market. So history basically says that two flat years do not traditionally follow one another, so if 2015 is flat then the odds favor a surprisingly strong 2016.

EQ: One of the issues in the wall of worry is the Fed’s decision in December. In this week’s Sector Watch report, you looked at the possibility of the Fed keeping interest rates essentially in line with inflation. How has the market performed historically when that has happened versus periods when the range was wider?

Stovall: The question is whether the Fed is going to raise rates in December, and we think they will. We also believe that by the end of 2016, the Feds funds rate will be anywhere between 1.0% and 1.5%. So yes, the Fed will be taking an upward-trending policy even in an election year. However, we really don’t see the Fed overly aggressive, and this rate-tightening cycle will probably take two years to be completed.

That said, rather than the Fed trying to boost the Feds funds rate to the traditional two percentage points above the Core Personal Consumption Expenditures level, which would imply a more than 3% Fed funds rate, the most recent FOMC minutes implies that the Fed would be happy with a zero-real rate interest rate. That means the Fed funds rate would be equal to the rate of inflation.

So I went back to 1960, which is when the PCE started and broke these real-rate ranges into quintiles. We’re in the lowest quintile, meaning that a real interest rate that’s between -1% and 1.3%. On average, the S&P 500 gained 6.8% in the coming 12-month period whenever we’ve been in that quintile. Now you might think that’s good, but it’s actually below the average of 8.4% for all years. However, the frequency of advance was very strong at 94% as compared to the normal 72% of the time. So in a very low real-rate environment, investors should not get greedy and expect a higher rate of return, but you can feel a little more confident of a likelihood that the market will be higher a year from now.

EQ: As you also noted in the report, as the range between interest rates and inflation widens, average price appreciation does go up while the frequency of advance goes down. Does this suggest that our prolonged period of low volatility may also be coming to a close and we’ll be operating in a different environment?

Stovall: That’s a good observation because we have been in a very low volatility environment since this bull market started. Traditionally, we have about 60 days in every rolling 12-month period in which the market is up or down by 1% or more. Yet, we’ve only been averaging in the mid-40s over the last year. That’s well below the average since 1960 and even further below the average of 80 since 2000. But that number has been creeping higher, as it usually does when we move into the later stages of a bull market. So I would tend to say that as real interest rate rises and as the bull market ages, we probably will end up seeing more and more volatility.

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