December Performance of US Equities

US equities generally perform well in December, benefiting from favorable seasonal trends.

The S&P 500 has shown a median return of +1.5% during December over the past 45 years, achieving positive returns 73% of the time. According to Morgan Stanley (NYSE:MS), the second half of December typically outperforms the first, with a median gain of +1.2% compared to just +0.2% earlier in the month.

This positive trend is also observed in smaller stocks. The Russell 2000 usually records a higher median return of +2.5% in December, with a 76% chance of positive performance.

Similar to the S&P 500, small-cap stocks tend to rally more significantly in the latter part of the month, reporting a median return of +2.7%, while the first half shows a slight decline of -0.5%.

Morgan Stanley highlights that sentiment among corporations, consumers, and investors has been improving recently. Indicators like the Conference Board Consumer Confidence Index and University of Michigan Consumer Sentiment have risen post-election, but optimism remains lower than the surge seen after the 2016 election. Currently, these measures are at the 34th percentile since 2000, well below the 72nd and 74th percentiles observed one and three months after the 2016 elections.

Morgan Stanley strategists, led by Michael J. Wilson, believe that greater clarity on tariffs could catalyze further gains in sentiment indicators. Despite the positive seasonal outlook, strategists urge caution regarding broader implications. They note that while December's seasonality may benefit small caps short term, it likely won't trigger a significant rotation from large caps.

The bank also notes that the correlation between stock performance and bond yields remains positive, suggesting equities are responding well to robust macroeconomic data. This situation, described as a "sweet spot" for interest rates, supports valuations as the year concludes.

The report states that yields below a certain range can be tolerated by equities, assuming the cause is Federal Reserve rate cuts without substantial growth slowing. Conversely, higher yields might also be acceptable if the increase in rates is gradual and driven by stronger nominal growth.