What Happened in December

There was no “Santa Rally”; December was a down month. Interestingly, December works the opposite of January. When it comes to averages, the January effect is watched because - historically speaking – there’s a wide differential in the following year’s return if January itself is up or down. If you’re an equity investor, you “root for” January being a good month, because it’s correlated with better future returns. December is the opposite – you’d be rooting for a down month, because that’s correlated with better forward returns than if December was up.

All that said, I’m not a fan of using conditional probabilities for any month. The ranked order usually remains the same (for January, up is better than down; for December, down is better than up), but the margins and odds that go along with it largely depend on the date range you choose and can be threadbare at best. Seeing a down December is technically a positive, but it isn’t a critical variable I’d want to bet on either.

What’s better? Valuation spreads. To beat a dead horse here, that’s still the biggest “what’s different this time” in this cycle. Analyzing differences can be helpful if there are discernable patterns around them historically. And this variable has some pretty clear patterns. The wider valuation spreads have been, the more likely the equity market is to be higher one year out.

The December selloff spiked valuation spreads for the broader market back to top decile levels – usually seen in recessions. Statistically, there’s still a lot to play for. Even top quartile valuation levels (our situation) don’t diminish average returns that top 20% historically. Mathematically, this doesn’t look anything like a “complacent” market to me.

If you’re worried you might have to put up with outsized volatility to see double digit returns from this dataset, history shows the opposite, at least on a month-to-month basis. Volatility isn’t much different when spreads are wide or narrow, both offering the lowest volatility of the quartiles.

That means historically risk adjusted returns are twice as good when valuation spreads are wide as when they are narrow. This is current our situation. This level of “fear” doesn’t just produce strong returns, it produces strong returns with strong odds – a cohesive pattern. Sure, it could certainly be different this time (there is no 100% odds) - but what if it’s not?

And it is different – mainly because it’s always different. There’s more uncertainty about trade, tariffs, and monetary policy than most years. The only problem using uncertainty to trim your equity exposure is that extreme concern is historically more likely to be a buy signal. The more uncertainty there is (see trade policy uncertainty below), the more likely the market is to be higher one year out.

Why? The more visible the headwind is, the more likely it’s already been discounted. If that sounds a little nuts given the equity market has been up over 20% two years running and is expensive, I get it. But strong markets usually lead to strong markets, valuation doesn’t have a good track record for forward returns, and wide valuation spreads continue to confirm this level of market fear. So, despite all the concerns as we head into 2025, it’s hard to look at this data and not be interested in equities.

This information is provided for educational purposes only and is not a recommendation or an offer or solicitation to buy or sell any security or for any investment advisory service. The views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Opinions discussed are those of the individual contributor, are subject to change, and do not necessarily represent the views of Fidelity. Fidelity does not assume any duty to update any of the information.