Wall Street Has Lots of Questions. Stock Markets Might Not Like the Answers They Get This Week.

Wall Street is still hoping for an end-of-year rally to lift the S&P 500 to 7000. (Courtesy NYSE)

Key Points

• Investors are cautiously optimistic as the final trading week of the year begins, with market volatility increasing and Treasury yields rising.
• Megacap technology stocks mostly have declined this month, prompting a rotation into cyclical sectors like consumer staples and financials.
• Upcoming economic reports, including consumer price inflation and the jobs report, will test narratives about the economy and Federal Reserve policy.

Wall Street could find answers to some of its most important questions over the next five days as the final full trading week of a difficult year looks set to provide key tests to narratives about the economy, artificial- intelligence stocks, and the path of the Federal Reserve’s interest rate policy.

Investors enter the week, which typically marks the start of a traditional late-December rally, in a cautiously optimistic mood, with market volatility gauges ticking higher and benchmark Treasury bond yields trading north of levels seen prior to last week’s interest-rate cut by the U.S. central bank.

Megacap tech stocks also are on the back foot, with declines this month for every member of the so-called Magnificent 7 cohort apart from Tesla , and big late-week declines for Oracle and Broadcom following mixed quarterly earnings updates that added to concerns over near-term profitability.

The pullback in tech stocks over the past month, paired with gains in cyclical sectors such as consumer staples, materials, and financials, has raised the issue of a so-called rotation trade away from AI-adjacent names to those offering more value and growth prospects over the coming year.

“This rotation is not surprising, especially as we head into year end,” said Rick Gardner, chief investment officer at RGA Investments in Raleigh. “The big question for 2026 is whether or not investors will remain comfortable with the elevated valuations in big tech and AI stocks.”

Further declines in the Mag 7 this week likely will accelerate that pace of that trade, particularly if performance is separated from the recent rise in Treasury yields.

“It is tempting to link the recent selloff in the bond market to the struggles of the stock market,” said Jonas Goltermann, deputy chief markets economist at Capital Economics.

“But the selloff has been concentrated in a handful of firms that are among the most heavily exposed to the AI data center buildout, which suggests that the main driver of the tech sector’s fortunes remains sentiment around the sustainability of the AI boom,” he added.

Bond markets, however, could extend their selloff this week if the delayed consumer price inflation report, to be released Thursday, suggests a further quickening of price pressures in November.

That could trigger another leg higher in Treasury yields that would test assumptions for further Fed easing over the first half of next year.

On the flip side, a weaker-than-expected reading for the jobs report for November, expected on Tuesday, would stoke concerns over a rapidly deteriorating labor market and ignite recession concerns in the world’s biggest economy.

With all that ahead over the next five days, the fate of the traditional Santa Claus rally hangs in the balance. Stocks typically outperform over the second half of December, but often will rise over the final days after the Christmas holiday and the first two trading days in January.

The S&P 500 has fallen around 0.32% in Decmeber but is still more than 16% higher for the year and sits within 2.5% of 7000. The rotation trade, meanwhile, could take the Dow Jones Industrial Average closer to 50,000 by the end of the month.

This week’s market performance likely will determine if both of those thresholds will be reached.

Beyond that, it could get trickier.

“Ultimately, we are bullish and expect a soft landing environment for valuations that will be placed on structurally strong earnings,” said analysts at Citigroup led by Schott Chronert, who carry an end-2026 price target of 7700 for the S&P 500.

“But don’t expect the same degree of upside asymmetry in equity market performance to exist from this starting point,” the analysts cautioned.

Write to Martin Baccardax at martin.baccardax@barrons.com