Wall Street Week Ahead -'Santa Claus' Stocks Rally?

Investors are closely watching the latest news on the rapidly spreading Omicron variant for signs of how much the virus could impact the U.S. economy and earnings as the market heads into what has historically been a strong time of year for equities.

Overall, the S&P 500 is slightly ahead since Nov. 24, prior to news of the variant hitting markets. It marked a record-high close on Thursday, as encouraging developments gave investors more ease about the economic impact of the variant.

"The market is extremely reactionary now and every little bit of news has a huge impact," said George Young, a portfolio manager at Villere & Co. Young is planning on taking advantage of any Omicron-induced volatility to add to stocks that rely on tourism and travel such as bank company First Hawaiian Inc . Shares of the company are up 14.4% for the year to date.

The Omicron variant is causing infections to double in 1.5 to 3 days, according to the World Health Organization. The variant now accounts for 73% of all new U.S. cases, up from less than 1% at the beginning of the month.

Still, questions about Omicron's virulence have made investors less pessimistic than the original reaction. The S&P 500 closed down 2.3% on Nov. 26 after the variant was discovered, on fears of fresh economic lockdowns.

A South African study offered hope about the severity of Omicron and the trend of COVID-19 infections on Wednesday. Shares of vaccine makers slumped in December as investors expect the Omicron variant's impact to be limited based on recent data.

That bodes well for what is known in the market as a Santa Claus rally. Historically, U.S. stocks have risen during the last five trading days of December and the first two days of January in 56 out of 75 years since 1945, according to data from CFRA Research. This year, the time period starts on Dec. 27. The average Santa Claus rally has boosted the S&P 500 by 1.3% since 1969, according to the Stock Trader's Almanac.

It is unclear to what extent Wall Street analysts expect Omicron to affect earnings and the economy. Estimated 2022 S&P 500 earnings growth was at 8.3% as of Friday, compared with 8.0% at the start of December, according to Refinitiv data.

Goldman Sachs cut its estimate for U.S. GDP growth to 3.8% from 4.2% due to the uncertainty of the impact of the Omicron wave.

Possible Volatility

While there will likely be some economic impact from Omicron, U.S. consumer spending will likely remain strong, said Cliff Hodge, chief investment officer for Cornerstone Wealth.

He is focused on any signs that Senator Joe Manchin could reach an agreement to support President Joe Biden's signature $1.75 trillion Build Back Better climate and social spending bill. Manchin, who would provide one of the key votes to pass the bill in a divided Senate, said on Sunday that he could not support the bill in its current form. Senate Majority Leader Chuck Schumer said that the Senate will vote on the bill in early January.

"We need a little bit of good news whether on the Manchin front or Omicron to get a rally going," Hodge said. "We are fully invested and anticipate a little bit of a relief rally into January."

The week ahead will be light on economic data, with the release of the S&P Case-Shiller U.S. home price index on Tuesday among the few notable data points.

The lack of new reads of the strength of the economy at a time when coronavirus case counts are rising may leave the stock market more volatile through the end of the year, said Dana D’Auria, co-chief investment officer of Envestnet PMC.

"The market has gotten pretty good at pricing in and leading off from what we are learning about on the health side," she said.

Should Omicron cases continue to spike or there are signs that economic restrictions could be reimposed, investors will likely rebalance into the shares of giant technology companies such as Apple Inc that have emerged as defensive plays given their large cash positions and revenue growth as a result of remote work, D'Auria said.

"At the end of the day if Omicron really causes problems I would be ready for a more volatile market" well into the new year, she said.