Why the stock market fell in December and what it means for the future

A devastating year for stock Exchange is rushing towards its end, but not before December has delivered its final verdict to investors.

After rallying in October and November, the S&P 500 fell for five straight days earlier this month. Each of the major indexes fell at least 1.5% in December, but a year-end surge known as the Santa Claus rally could end the year on a high note.

The uncertain near-term outlook for the U.S. economy has amplified market volatility as recession fears weigh on expectations for corporate earnings, analysts told ABC News. However, the reason for the market’s long-term optimism came after a month-long streak of falling inflation and an expected slowdown in rate hikes at the Federal Reserve, some analysts said.

“December is the toughest month for many to trade,” Ed Moya, senior market analyst at brokerage OANDA, told ABC News. “This year, many investors are unsure about the fate of the US economy.”

Still, next year raises hopes that an eventual slowdown will give way to a rebound in equities, Adam Turnquist, chief technical strategist at LPL Financial, told ABC News.

“While there is downside risk, overall things look more constructive for equities as we look to 2023,” he said.

Here’s what you need to know about stock market performance in December and what it says about stock markets going forward.

How stocks are doing in December

Over the past few decades, the stock market has generally ended the year up.

Since 1950, the S&P 500 generated average returns of more than 1.5% in December, LPL Financial said in a report on Monday.

Losses so far this month shouldn’t necessarily deter investors, as returns typically arrive in the second half of the month, according to the report.

The Santa Claus rally, a seven-day period in late December and early January, has historically generated stock market gains comparable to a solid month, the report added.

This time around, the market’s performance will depend on how investors react to the latest inflation data and the political response of the Federal Reserveanalysts said.

A government report on Tuesday revealed that inflation stood at 7.1% last month from a year earlier, continuing a multi-month decline from a 40-year high reached over the summer.

However, inflation remains at more than three times the Fed’s target rate of 2%.

Inflation news nonetheless bolstered hopes among some investors that the U.S. could reach a “soft landing“, in which inflation returns to normal levels while the economy avoids a recession.

A day later, the Federal Reserve said it raised its short-term borrowing rate a further 0.5%, slowing an aggressive series of rate hikes while continuing its efforts to calm the economy and bring down inflation.

Increases in borrowing costs generally weigh on equities, as the measures aim to reduce inflation by slowing the economy and stifling demand. But the latest rate hike took the Fed back three straight increases of 0.75%, signaling confidence that the central bank can bring sky-high inflation back to normal levels.

Despite the positive sign, each of the major stock indexes fell nearly 1% on the news, in part because the Fed also signaled it wouldn’t start cutting rates until 2024.

Market outlook for 2023

Analysts said they expect market volatility and a potential recession by the first half of next year. Still, some predicted that a strong year-end would support the economy and markets.

“It’s possible the markets could go up or down a bit,” Dave Sekera, chief US market strategist at Morningstar, told ABC News.

“Our US economic team believes that if there is a recession, it will be short and shallow,” he added. “In our outlook for the second half of 2023, we believe the economy will rebound.”

OANDA’s Moya said the continued volatility stems from a host of factors, such as China’s zero-COVID policy, movement in inflation and the possibility of a recession.

“We’re probably going to see more choppy conditions,” he said. “It’s a tough economy to excite.”