A 'Santa rally' could push US stocks to new heights this winter, as buybacks and low bond yields help power the market

• Investors are optimistic stocks will stay strong in coming weeks, as the traditional "Santa rally" takes shape.
• This year, equities could be boosted by buybacks, low bond yields, a growing economy and bullish retail traders.

Inflation is at its strongest in 31 years, US stocks are at record highs, and coronavirus cases are soaring in Europe.

But that hasn't stopped investors getting excited about a possible "Santa rally" that many expect to push stocks to new heights this winter.

The end of the year has historically been a gift to US stock market investors. The S&P 500 has risen on average 1.1% in November and 2.3% in December since 1936, according to Bank of America, as traders try to get ahead of what was traditionally a January rally.

Yet investors are optimistic about stocks for other reasons, according to market watchers. These include the huge amounts of company buybacks coming through the pipes, strong economic growth, and the fact that bonds are so unattractive.

Stock buybacks for the S&P 500 reached a record high of more than $225 billion in the third quarter, according to data from S&P Dow Jones Indices, and are likely to top $200 billion in the last quarter of 2021.

"Buybacks are important because [companies have] historically been the number-one buyer of US equities," Ben Laidler, global markets strategist at eToro, told Insider. "And that buyer basically disappeared last year because companies pulled in their horns."

Relatively strong economic growth — which helped companies post robust third-quarter earnings — is also cheering up investors.

Although consumer confidence has taken a hit due to strong inflation, Goldman Sachs expects the US economy to grow at an annualized 4.5% in the fourth quarter, up from 2% in the third.

Federal Reserve Vice Chair Richard Clarida said Friday the economy is in a "very strong position."

But perhaps the key reason stocks could push higher in the next few months is "TINA" — the belief among investors that There Is No Alternative to equities. That's because the return on bonds when inflation is taken into account, known as "real bond yields," is near record lows.

"If you are a long-term investor — call it 10 years — and you have a pot of money, putting it in the bond market is pretty ludicrous," Fahad Kamal, chief investment officer at Societe Generale private bank Kleinwort Hambros, told Insider.

Read more: A fund manager who's beaten 96% of peers in the past 5 years shares the 16 stocks he's most bullish on — and why growth will make a comeback in 2022

Retail traders certainly seem to believe in TINA. Call option buying, which is a reliable indicator of retail interest, has picked up to the highest levels since the first quarter.

"Equities are delivering their typical Q4 melt-up, helped by retail buying," Emmanuel Cau, head of European equity strategy at Barclays, said in a note last week.

He added that retail traders are a "big driving force ... and don't show signs of fatigue."

Goldman Sachs expects the S&P 500 to rise to 4,850 in the next three months, from its Friday close of 4,698. Research house Fundstrat thinks it will top 4,800 by year's end.

Yet there are certainly risks on the horizon. eToro's Laidler said the Santa rally may have come early this year, given that the S&P 500 shot up by almost 7% in October. Stocks are regularly hitting new highs, giving some investors the jitters.

Meanwhile, US inflation is running at its hottest in 31 years, and the Federal Reserve could be forced to suddenly cut back its support for the economy.

And coronavirus cases are now rising sharply in Europe, which could weigh on the global economy and worsen supply-chain disruption.

Wharton professor Jeremy Siegel said on Friday that he thinks a 10% correction is coming. Yet even he said he's staying fully invested in stocks — because "there is no alternative."