Key takeaways:

• Positive signs around inflation and China approach to managing COVID could give a boost to the stock market, with the traditional Santa Rally period also nearing

• On the other hand, if this month lower inflation reading proves a false dawn, sentiment may swing against the recent rally

Earnings are out of the way, and the year is winding to a close. However, that doesn't mean 2022 is done and dusted. In fact, with another series of central bank meetings next month, and a swathe of data to pore through before then, the stakes are as high as ever.

Can the market end what has been a difficult year on a high note? Is the recent rally a sign of things improving, or might there be more trouble on the horizon for investors?

Here are three reasons why the stock market could rally to end the year, and a key hurdle that could derail proceedings.

1. Easing Inflation Draws a Fed Pivot

Last week US inflation data showed a modest decrease in the pace at which consumer prices are increasing. Although a reading of 7.7% is by no means a signal that inflation is where it needs to be, the result, not only less than expected, is a signal that we may well have seen a peak in US inflation.

The CPI result back in June, which showed consumer prices grew at 9.1%, appears to give weight to the notion that inflation may have peaked, with monthly readings declining since then. 

Why does this matter for investors? Historically, the top of an inflation cycle has rewarded investors who entered the stock market at that time. If inflation is showing signs of gradually slowing, the Federal Reserve may feel compelled to cut the size of its interest rate hikes, or even wind back its tightening policy at a lower peak interest rate than otherwise might be the case.

There is one more CPI result and Federal Reserve meeting scheduled for next month. Another report showing inflation is easing could encourage the US central bank to deliver a 50 basis point rate hike instead of 75 basis points, which may provide some impetus for the market to rally.

2. China Adjusts its COVID Policy

While much of the world has moved on with the way it manages COVID, China stringent approach has been a thorn in the side of the global economy. 

It has put the brakes on demand for a number of key commodities, and concerns about a slowdown in China have spread to the rest of the world.

Recently, the country made the first steps in what could be a pivot away from COVID-zero, albeit for the time being the changes are more akin to tweaks, as opposed to a formal shift in policy. Nonetheless, with as many as 20 amendments, and moving away from a one size fits all' approach, investors are cautiously optimistic that changes could reignite growth in the world second largest economy.

For investors, if China shows further signs of transitioning towards a COVID normal' outlook, it could be a net positive for commodities and the market at large.

3. Traditional Santa Rally

Of course, we can't forget the seasonal phenomenon that is the Santa Rally.

History shows that the end of the year is one of the strongest periods for the stock market, with investors generally upbeat about the year-end prospects for equities.

Just why that is the case is something that continues to baffle onlookers and researchers, but over the last three decades, global markets have risen close to 80% of the time throughout December. That result is well ahead of any other month during the year.

However, it is not just the frequency of a positive month for equities that brings festive cheer to investors, because the average return during December has outperformed all other months as well. 

While it would be unwise to assume that favourable historical data will lead to a certain outcome in the future, you can't argue with the fact that this phenomenon has been a consistent story. 

Read more about the Santa Rally phenomenon here.

What Could Derail a Rally?

Although there are some optimistic signs for investors to keep an eye out for in the lead-up to the end of the year, it is worth pointing out that risks remain. 

Perhaps the most prominent obstacle that could sidetrack a positive finish to the year for the stock market is if recently improving inflation turns out to be a false blip'.  That means, if next month inflation data turns higher, investor nerves could creep in once again. 

With commodity prices rallying, and concerns about a potentially bleak winter in Europe that may severely test the region energy mix, investors will need to keep an eye out for signs that suggest inflation remains stubbornly elevated, which could give rise to stagflation.

If you want to learn more about stagflation, read here.