Steep drop in stocks may spur year-end rally

updated 3:22 p.m. ET Dec. 21, 2008

NEW YORK - Investors head into a holiday-shortened week with optimism that recent moves to prop up the ailing auto industry and slash interest rates might trigger a year-end rally.

Like the deep discounts luring holiday shoppers to the malls, the steep drop in stocks over the past year has made many blue chip shares more attractively priced. And big institutional investors might use the last seven trading days of the year to snap up some bargains.

The downturn that began in October 2007 spread through the entire market in the past year and damped widespread demand for all but the safest investments, particularly government bonds. With the benchmark Standard & Poor's 500 index down 40 percent in 2008, investors are hopeful about a rally in the past month and wondering what to expect next year.

Even if investors stream into the market, it still might not be enough to save what is expected to be one of Wall Street's worst years on record. Volume is expected to be light in a week shortened by the Christmas holiday and an early close on Christmas Eve.

"Only the folks that need to trade are going to trade this week," said Axel Merk, portfolio manager at Merk Funds. Decreased volumes, he said, can mean added volatility.

With little in the way of corporate news expected this week, investors will turn their attention on economic reports. Data slated includes a report on new home and existing home sales for November, the government's third-quarter gross domestic product report, and a reading on consumer sentiment for December.

Investors also will look for any signs about how retailers are faring in the last sprint before Christmas. From flagship department stores to main street shops, consumers were greeted this past weekend with hefty markdowns, extended hours — in some places, around-the-clock shopping — and even extra-cheery customer service as merchants tried to woo shopppers during the final holiday countdown.

And Wall Street might also be attracting buyers if 2008 follows the tradition of a Santa Claus rally. The market has participated in the year-end rally seven out of the last eight years.

"Santa Claus tends to come to Wall Street nearly every year, bringing a short, sweet, respectable rally within the last five days of the year and the first two in January," according to Jeffrey Hirsch and Yale Hirsch, the authors of the Stock Trader's Almanac. "This has been good for an average 1.4 percent gain since 1969."

There was some indication on Friday that investors were feeling a bit more optimistic. Stocks finished a bumpy session mostly higher, as investors were encouraged by the government's pledge to lend as much as $17.4 billion to U.S. automakers.

Weak recovery won’t spur jobs, Fed warns Unemployment likely will remain high for the next several years because the economic recovery won't be strong enough to spur robust hiring, Federal Reserve officials warned Tuesday.   Sen. Dodd urges financial overhaul Stimulus watch: Pay raise counted as saved job Banks face Feb. 1 deadline on compensation Obama: Job losses expected to continue

For the week, the Dow ended down 0.59 percent, while the S&P 500 finished up 0.93 percent and the Nasdaq up 1.53 percent. All the indexes are still down more than 35 percent for the year.

Besides the auto bailout, sentiment has also grown a bit more cheery in the past few trading sessions after the Federal Reserve cut the benchmark fed funds rate to as low as zero. Investors are looking for any signs that the government is being proactive about reviving the battered U.S. economy to avoid a protracted recession.

And, there's also some enthusiasm that the worst of the bear market may be over. The S&P 500 has already bounced 20 percent higher from its lows in November.

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