U.S. stocks sold off on Friday on rising bond yields but ended the shortened trading week higher, reversing the previous week’s losses.
The S&P 500 ended Dec. 27 at 5,970, up 1.77 percent for the week; the Dow Jones closed at 42,922 up by 1.54 percent; the Nasdaq finished the week at 19,722 up 1.80 percent; and the small-cap Russell 2000 was up 1.04 percent to end at 2,244.
Stocks began the trading week with a rally in tech shares as the AI trade broadened beyond Nvidia and the other large tech stocks.
The arrival of the Santa Claus rally aided the positive Wall Street sentiment and further boosted the NASDAQ and Russell 2000 indexes.
Santa Claus rally is a term Wall Street uses to describe the strong performance in the most speculative parts of equity markets, such as the small caps shares included in the NASDAQ and Russell 2000 indexes, during the last week of December and the first week of the new year.
The gain in these indexes is driven by end-of-year bonuses followed by new money flows at the beginning of the year and a relaxed holiday atmosphere. These create a positive sentiment among retail traders and investors, who tend to be more emotional than institutional investors chasing smaller speculative stocks.
The Santa Claus rally in the tech sector gained steam on the shortened trading session on Dec. 24 and Dec. 26 after the Christmas Day pause. However, it reversed course on Friday on lower bond prices, which drove yields higher for another week. The benchmark 10-year U.S. Treasury bond yield ended the week at 4.62 percent, up from 4.52 percent in the previous week, 4.19 percent at the beginning of the month, and 3.63 percent in early September.
Bond yields have risen despite an accommodative monetary policy as inflation remains elevated by almost every measure, above the Federal Reserve’s targets.
Then there’s the soaring government debt, as the U.S. Congress keeps raising the debt limit.
These trends make it less likely that the nation’s central bank will cut the Federal Funds Rate in its next meetings this spring, as the Federal Market Operations Committee (FOMC) indicated in last week’s meeting.
The likelihood of no further cuts in the Federal Funds Rate, a benchmark for short-term debt yields like Treasury Bills, makes investing in long-term fixed-income securities like bonds less appealing.
Meanwhile, higher bond yields are a headwind for stocks in three ways. First, they hurt valuations, as these yields are usually the “risk-free” component in almost every equity valuation model.
Second, higher bond yields drive higher corporate yields and mortgages, which hurts the shares of publicly listed companies that are heavily leveraged, like utilities, and interest rate-sensitive companies like home builders.
Third, higher bond yields push the dollar higher, which hurts the earnings of listed companies with a large overseas presence, like big techs.
Meanwhile, a strong U.S. dollar is a headwind for emerging markets (EM), which have been underperforming Wall Street in 2024.
“When investing in EM, you have to remember you’re taking a currency trade risk as well,” Vince Stanzione, CEO and founder at First Information, told The Epoch Times in an email.
“So, a U.S. dollar-based investor, not only do you need to make money on the stock or index, but you also need the local currency to perform well or at least stay the same against the U.S. dollar, and that is tricky as I believe the U.S. dollar will remain strong in 2025.”
Looking into the next week, Wall Street could get another leg up from the Santa Claus rally and the spreading of AI euphoria beyond big techs.
However, new statistics on the U.S. economy will be the decisive factor for the direction of economic growth and inflation, determining the pace for the next trade.
One statistic to watch is the Dec. 31 release of the housing price index. Rising housing costs have been one of the drivers of higher inflation as measured by the Consumer Price Index (CPI) and higher bond yields.
Another statistic to watch is the initial weekly jobless claims on Jan. 2, 2025. They will set the tone for the December payroll report, which the Federal Reserve closely follows in setting the pace of monetary policy.
While it’s unclear which way these statistics will come up, one thing is certain: volatility will continue on Wall Street.
