The Santa Claus rally in the stock market could stumble this year as Fed hawkishness and rich valuations spook investors, Bank of America says

• December has been the strongest month of the year for stock returns based on historical data.
• But the Santa Claus rally could be derailed this year as fears of the Omicron virus hit markets.
• "We remain cautious on S&P 500 amid a hawkish Fed tightening into an overvalued market," Bank of America said on Thursday.

Investors have been conditioned to expect positive stock market returns in the month of December, as it is seasonally the strongest month of the year, according to data from Bank of America.

The move higher is often dubbed the Santa Claus rally because stocks have returned an average of 2.3% in December since 1936 and generated a positive return 79% of the time.

Despite those favorable odds, that doesn't mean stocks are immune to a sizable sell-off, as was seen in December 2018 when the S&P 500 plunged 7.6% due to a hawkish Fed and growth concerns.

Now those similar concerns are resurfacing this year, and they could could derail any year-end rally in stocks, Bank of America's Savita Subramanian said in a note on Thursday.

"Any resurgence in COVID could exacerbate lingering supply shortages," Subramanian said before acknowledging that more information is needed to assess how deadly and transmissible the Omicron variant is.

Another risk that could slowdown growth is "an inflation-led consumption hit, especially as fiscal and monetary stimulus runs out," the note added.

On November 30, Fed Chairman Jerome Powell told Congress that speeding up the tapering of its monthly bond purchases could be warranted, even in the face of a new coronavirus strain. The comments signal that Powell is now more focused on containing inflation than decreasing unemployment, according to Subramanian.

The Fed's shift in stance, combined with rich valuations in the stock market, could spell trouble for investors. "We remain cautious on the S&P 500 amid a hawkish Fed tightening into an overvalued market," Subramanian warned.

But according to LPL's Ryan Detrick, investors shouldn't lose faith about the potential for a Santa Claus rally if the next two weeks are bumpy for the stock market.

"December might be strong for stocks, but remember it is the second half of the month when Santa tends to show up," Detrick said on Wednesday.