By Lewis Krauskopf and Saqib Iqbal Ahmed
NEW YORK (Reuters) – Stock market investors are bracing for a turbulent end to the year brought on by uncertainty over the Federal Reserve’s short-term interest rate cuts and growing concerns that artificial intelligence companies, which have driven the market to new records this year, are overvalued.
The market continued to decline last week, even though stock indices rebounded sharply on Friday. At Friday’s close, the benchmark S&P 500 and Nasdaq Composite fell 4% and 7% respectively from their all-time highs in late October.
After a relentless rally since April fueled by AI enthusiasm and expected rate cuts, market exuberance this week gave way to caution, with investors warning of further turmoil in the holiday season as doubts grow over those two key issues.
“We’re certainly approaching what looks like it will be a volatile holiday season,” said Eric Kuby, chief investment officer at North Star Investment Management in Chicago.
“Without a rate cut…and with this renewed fear, it looks like it’s going to be a much tougher holiday season than we previously expected.”
Volatility increased dramatically last week, with the Nasdaq and S&P 500 on Thursday experiencing the biggest intraday swings since US President Donald Trump’s “Liberation Day” tariff announcement in April sent markets soaring.
Despite a modest pullback on Friday, the Cboe Volatility Index, known as Wall Street’s “fear gauge,” remains above the key 20 level, suggesting persistent investor anxiety.
The VIX futures curve – a snapshot of volatility expectations for the coming months – also appears unusually flat, indicating the market’s expectation of persistent volatility.
Still, many investors have said a pullback was necessary after the S&P 500 soared 38% from its April low year-to-date through the end of October. Following Thursday’s decline, the index was down 5% from its October high, its first 5% decline in 149 days, said Keith Lerner, chief investment officer at Truist Advisory Services. By comparison, there has been an average of 77 days between pullbacks of at least 5% since 2010, Lerner said.
The S&P 500’s price-to-earnings ratio, based on earnings estimates for the next 12 months, had fallen to 21.8 as of Thursday, down from 23.5 about a month ago, according to LSEG Datastream. But that current valuation still remains well above its 10-year average of 18.8.
“You’re resetting those high expectations,” Lerner said. “That probably has a little further to go in terms of people having more doubts and uncertainties.”
Meanwhile, retail investors who bought the dip following the April tariff drop and helped the market recover from the sell-off are showing signs of fatigue.
“While we don’t see retail investors contributing to the sell-off, they are also not showing strong interest in buying the dips,” JPMorgan analysts wrote in a note Thursday.
A crucial uncertainty that will haunt markets in the coming days is whether the Federal Reserve will cut rates at its December 9-10 meeting, a move that was considered a given until late last month.
Investors were divided over the implications of Thursday’s delayed release of September jobs data, the last jobs report before next month’s meeting. It showed payroll growth accelerated, but the unemployment rate also hit a four-year high.
New York Fed President John Williams appeared to raise hopes on Friday, saying the central bank can still cut “in the near term,” but by late Friday market bets on a cut next month were barely higher than a coin toss.
“It could well be the case that we don’t get a change in overall tenor until the Fed is back in clearer rate-cutting mode,” said Yung-Yu Ma, chief investment strategist at PNC Financial Services Group. “That’s going to happen sooner rather than later, but it may not happen before the end of the year.”
Technology stocks, which have led the bull market that began more than three years ago, have been at the center of the recent selling, with sharp declines in stocks like Oracle and Palantir Technologies that had been big winners in the AI trade.
Strong earnings on Wednesday from AI leader Nvidia, whose chips have been instrumental in the development of AI infrastructure, failed to calm nerves, and the stock even fell on Thursday after its report.
“That tells me that investors have been a little scared and I think they just need to regroup,” said Don Nesbitt, senior portfolio manager at F/m Investments.
The year-end period has generally been upbeat for stocks, and some investors say there could still be cause for holiday cheer. December has ranked as the third best-performing month of the year, with the S&P 500 rising an average of 1.28% since 1928, according to LSEG data.
December’s performance has been even stronger when November, historically the strongest month, has seen declines, according to data since World War II tracked by Sam Stovall, chief investment strategist at CFRA. In such cases, December has shown nearly double its average historical gains.
Some investors said they saw opportunities. Because of lofty valuations, Nesbitt says he has been underweight the information technology sector, but “it’s starting to look a little more attractive.”
Jack Ablin, chief investment officer at Cresset Capital, said investors are often reluctant to sell their winners in December to avoid paying capital gains taxes.
“I don’t think investors want to run away from the markets,” Ablin said. ”What they really want to do is dig deep and find opportunities.”
(Reporting by Lewis Krauskopf; Editing by Richard Chang)
