Hello, readers. Our team members are spread throughout the US (from New Mexico to New Jersey, Florida to Ohio, and Minneapolis), and I think it is safe to say that we are all enduring the bitter cold. We hope you are comfortable and staying warm. I can tell you that we personally have received over a foot of snow in the past 48 hours where I live (Cleveland, Ohio).

After a slow start to 2024, the Dow is now up 0.46%, the S&P 500 is up 1.47%, and the Nasdaq is up 2.0%. After a spectacular 2023 with the S&P 500 up 24% and the Nasdaq’s 43% gain, it was inevitable that there would be some profit-taking early on. Is the profit taking over, and will we have another good year in 2024? We will explore this question.

It is important to note that we are in year four of the Presidential cycle. Last year, we continually commented on this important cycle and its reliable historical indicator. This fourth year (the election year) is the second-best year of all four years, second only to year three (last year), which is the best year of the cycle.

It's Official

The S&P 500 printed its first all-time high in two years on Friday. It took 511 trading days, and the S&P 500 fell as much as -25% during that time. It was the longest drawdown since the Great Financial Crisis and the sixth longest since 1950.

It’s often said that trends correct through either time (511 days) or price (-25%), but this time, it was both. Thus, it emerged from a two-year base that took the price nowhere (if you owned the cap-weighted index), but now the bulls must defend the prior highs at 4800 to avoid a failed breakout. See illustrations of the S&P 500 below:

And how exactly did financial conditions look like back in early 2022 when the S&P 500 last hit a new high? See the chart with some comparisons below:

The S&P 500 index was not the only market that saw new highs. See additional market charts below:

Why Should We Care About New Highs in These Markets (and Many Stocks within Each Market)?

Once price enters uncharted territory, there’s virtually no price memory or overhead supply to prevent it from trending higher. It is why most analysts believe that when markets (or stocks) hit new highs, they have a propensity to move higher. Momentum typically yields more upside, especially if the market or stock is in new territory.

Looking back in history, there have been 11 similar instances of new all-time highs following bear markets, defined by prior declines of at least -20%. The table below provides a comprehensive overview of the expected return profiles associated with this study, done by Nautilus Research.

It is important to note that while continued upward momentum is typically observed, returns in the one-week to two-month range can be mixed. In the case of 2007, it essentially marked a ‘double top,’ but in the other 10 instances, strong returns were witnessed from five months up to one year forward.

Last week, we provided three different scenarios that could play out in the economy this year and the potential impact these scenarios could have on the stock markets.

Broadening Out

Even though the S&P 500 has demonstrated over the past few months that it is broadening out, the discrepancy between the cap weighted S&P 500 index and the equal weighted S&P 500 index (RSP) is big. See chart showing the difference below:

This continues to prove that significant inflows have been going into the index fund (SPY) and last year’s leaders. Therefore, capital continues to flow into the Magnificent 7 stocks, which currently comprise 30% or more of the S&P 500 index. One stock, Nvdia (NVDA), is already up over 20% for 2024. See chart below:

A Positive Technical Indication for the Markets

Being a student of the markets and involved with a firm that prides itself on recognizing technical indicators, I like to look at signs that we might see continued strength in certain markets.

One of the leaders of the S&P 500 besides Nvdia (shown above) is Microsoft (MSFT). Microsoft is also one of the technology leaders currently utilizing Artificial Intelligence and all things that can be done more efficiently by integrating AI into their software. Microsoft recently overtook Apple (AAPL) for the top spot of the world’s largest company.

Its trading pattern may be setting up for another move higher. Also, given its influence on the cap-weighted S&P 500, both patterns look alike. Those familiar with a “cup and handle” formation will get a kick at how beautiful these patterns appear. As they say in our business, though, “There is no guarantee that the future will look anything like the past or that this pattern will play out as technical analysts expect.” Take a look at the patterns below:

Money in Rotation

It might surprise you to learn which sectors of the market have seen investors rotating money over the past month. It is clear that one area that investors are currently pulling money from is bonds.

After a two-month decline in interest rates (bond prices rallied), investors are now avoiding bonds and other financials (Banks) and that, in some part, is causing the back-up in rates. Investors have recently become more confident in real estate. That is a testament to investors feeling the Fed is done raising rates. See chart on investor rotation below:

Mixed Signals

Since the start of 2024, the markets have gyrated up and down. Earlier this week, we saw two down days, and various indicators were flashing warning signs. Then, on Thursday and Friday, we saw two positive bullish days ending with new record highs in the S&P 500.

I firmly believe that continued uncertainty resides with what the Federal Reserve will do. We all remember well when they abruptly pivoted in early November of 2023 with the potential prospect of lowering rates a few times in 2024.

Certain inputs were released in October of 2023, showing weakness in several areas of the economy. Interest rates on the longer end of the yield curve came down quickly, the dollar weakened, and the stock market took off and had two of the best back-to-back months in a long time. Much of this was firmly embedded in the idea of more interest rate cuts than Chairman Powell had indicated (6 versus 3) and that they would start as soon as March 2024.

The economic numbers that have come in since late December indicate that we are unlikely to see any type of cut as early as March. Moreover, in the past few weeks, the economic numbers have indicated that we may not even see a rate cut in May. If this were to occur, it would be possible to see a 5-10% correction as the market would adjust to this new reality.

Let’s look at a few of the strong economic indicators that came in over the past month suggesting that there could be a delay in reducing the Fed Fund rate (we will also indicate if this is negative or positive towards a reduction in Fed Fund rates).

• Inflation ticked up to a recent reading of 3.4% on core CPI. This was above expectations. (Negative)
• Import prices in December were down 1.6% as compared to December 2022. (Positive)
• Export prices fell in December by 0.9% monthly and by 3.2% annually. (Positive)
• Capacity utilization was at a level of 78.6% for December. (Positive)
• The Philadelphia Fed Manufacturing Survey rose 2.2 index points, but is still at -10.6 in January. (Positive)
• The Empire State Manufacturing Index fell 29.2 index points in January to 43.7. (Positive)
• Housing Starts came in at a higher-than-expected 1.460 million in December. (Negative)
• Building Permits came in at much better-than-expected 1.495 million. (Negative)
• Existing home sales fell 1.0% month-over-month and 6.2% year-over-year to the annualized rate of 3.78 million in December. (Positive and a big reason why the Fed may be forecasting rate reductions)
• Retail sales in December rose 0.6% month-over-month. (Negative and a big reason for market sell-off early in the week)
• Weekly jobless claims fell by 16,000 from the previous week’s revised level in the week ending Jan. 13 to 187,000. (Negative and another reason for the sell-off earlier in the week. The Fed is counting on a weakening job market, and this is not happening yet)

There are even economists now predicting that we may not see any real reduction in the Fed Funds this year. Given the retail sales (consumer spending), the positive job market, and some areas of persistent inflation (shelter and food prices), there are plenty of forecasts for no rate cuts until later in the year.

Still others, like money managers Bill Gross and Jeffrey Gundlach, see a recession on the horizon, and both believe the Fed will be lowering rates sooner than later. There are many mixed signals.

A Historical Market Comparison - What Might the Market Do this Year?

I spent some time looking for historical periods that resembled 2023. As they often say with respect to investment markets, “History may not exactly repeat, but most often, they will rhyme.”

Happily, I found a study put together this week by LPL that looked for a high correlation between the 2023 S&P 500 market to other years going back to 1950. They discovered that the market in 1955 had the highest correlation to the 2023 market.

I thought I would share this study with you. However, it is important to keep in mind that the market in 1955 was very different than now. I doubt that 7 stocks were influencing 30% of the cap weighting of the S&P 500 back then. Also, the S&P 500 technology stocks, especially those even remotely involved with AI, were not in the market during that period.

Most likely, it was the industrial stocks that were the “go-go” stocks during 1955 and the darlings of the market. Nonetheless, we provide the summary of the report below. Most importantly, it should be used to see what the market performance looked like the year afterwards.

The table that follows also compares the top 10 highest correlated years to 2023. Several of these years are more recent and may have had additional technology/growth stocks that more closely resemble our markets today (see 1985, 1995, 2003, 2016, and 2023).

Please note that 1956 started off with a choppy market. See chart below:

Now, here are some other market factors that may have played a part in the week's trading

Risk-On

• The Russell 2000 (IWM) found support at the 50-DMA and bounced.
• New all-time highs were set in the SPY, the DIA, and the QQQ on Friday, which, of course, is bullish.
• Volume patterns improved across the board and were positive.
• Semiconductors led the market higher, up almost 8% on the week.
• Stocks are over key moving averages and bounced from oversold levels on a short-term basis (real motion), and the IWM bounced off of critical 50% levels in the longer-term averages.
• Rates rose, with TLT closing under its 50-DMA while stocks largely ignored the changes.
• Growth stocks hit new all-time highs, way outperforming value.
• For the S&P 500 and the Nasdaq Composite, market internals bounced from oversold levels, crossing into a positive reading from an oversold condition.
• The risk gauge remains positive.
• The euro found support on the 200-day moving average. A weaker dollar could be good for equities.

Neutral

• Volatility readings of one-month vs. three-months bounced off of oversold levels, but the longer-term still appears negative.
• The underperformance in foreign equities accelerated in January.
• There was a mixed read in soft commodities with a bounce off of compression -- although we are about to get a negative cross in DBA, possibly putting it in a bearish phase.
• Gold, after moving into a weak warning phase earlier in the week, recovered and closed back into a bull phase.

Risk-Off

• Nine of the 14 sectors closed lower on the week.
• Sentiment remains oversold on the narrow market rally.
• Despite the rally in stocks, copper appears to be in a bear phase.

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