The S&P 500, which the C Fund tracks, reached new all-time highs again last week. It reached over 3150 before trimming some of the gains on Friday.
Historically, December is the lowest volatility month for U.S. markets, and the most likely month to have a positive monthly gain. Out of the past 91 Decembers stretching back to 1928, 66 have enjoyed positive gains, which translates into a 72% positive chance. In particular, the last few days of the month are often called a Santa Rally.
In terms of the average monthly gain, December only comes in second place with a 1.3% average return, tied with April and behind July:
Last December was a notable exception from the norm of a positive and low-volatility December. With the huge sell-off that occurred through November and December, it ended up being the worst December for the stock market since the Great Depression, around the beginning of the historical dataset.
There are numerous potential reasons for December’s calm reputation. Investors are more focused on the holidays than the markets, very few companies report quarterly results during the month, Congress has limited time to pass newsworthy laws or changes, and in general geopolitical activity tends to wane during the season. During the last few days of the month, tax-loss harvesting has been largely completed, and investors have low volume trading days to push markets higher.
But, just like last year, there’s no guarantee of a positive and uneventful December this year. Markets have moved up in a nearly unbroken straight line through November, so the probability of at least a mild pullback is high.
In addition, stock valuations are currently high by most metrics, and S&P 500 earnings have declined mildly in recent quarters, meaning there has been a big divergence between stock market performance and underlying company fundamentals.
What can we learn from high yield junk?
In addition to equity markets doing well, high yield “junk” bonds have been doing well lately, particularly during the second half of November. These bonds are issued by companies with credit ratings that are below investment-grade.
Their yields have gone down and thus their prices have gone up, meaning that investors are less concerned about their solvency:
Although the TSP has no exposure to this particular asset class, the high yield credit market is considered an important barometer of corporate fundamentals, and therefore worth paying attention to. During the previous recession, junk bond yields spiked to sky-high levels of over 20%. They also spiked a bit during previous economic slowdowns in 2012, 2016, and late 2018.
Earlier this month, junk bond yields were rising and thus their prices were falling, which was a bearish sign. Usually, equities and junk bond prices are well-correlated, so when they diverge, investors tend to ask which market is “wrong”. From late October through mid-November, bearish investors were observing that junk bonds were not confirming the stock market rally as a reason to be skeptical of the rally. However, by the second half of November, junk bond yields have mostly calmed down and began confirming the stock market rally.
Some of the worst-rated bonds in the CCC category, however, are still performing poorly. Many of these are small energy or small telecom companies. Investors with a bearish outlook may view them as the first domino to fall, while bullish investors may view them as having problems mostly in isolation.
It remains to be seen how this will play out, but if one thing is clear, it’s that broad markets are currently complacent. Stocks have reached new all-time highs, equity volatility is near historic lows, and the junk bond market has calmed down.
A note on asset allocation
Investors should be careful not to chase recent performance based on quick emotional decisions. Asset allocation should usually be based on your long-term goals and your risk tolerance. Decisions to increase or decrease your allocation to equities, for example, should be well thought-out and applied for good reasons. For many investors, the Lifecycle funds can be ideal investment vehicles because they are consistently diversified and rebalance themselves over time.
More on the Lifecycle funds here: The Pros and Cons of Lifecycle Funds