Monthly Candles A Warning Shot Across Equity Bulls’ Bow; March Could Be Interesting

Two months into the year, January and February have traded similarly – early strength followed by weakness in the dying sessions. Equity bulls’ inability to hold on to gains comes amidst a spike in long rates. Short rates are behaving, but if the economy performs as expected, markets will begin to demand higher rates on the short end as well. A catch-22 is in play.

The year 2021 was quick off the blocks – essentially picking up where it left off. Last year, the S&P 500 (SPX) rallied 16.3 percent. In the first five sessions this year, it then rose 1.8 percent – passing the five-day rule, which posits that as go the first five sessions so goes the year. By the 26th, the large cap index was up 3.1 percent, to an intraday high of 3870.90. Then it hit the skids. By the time the month was over, it was down 1.1 percent.

As a result, the January barometer, which states that January predicts the rest of the year, was forecasting a down year. Although it must be pointed out that not all the major US equity indices ended up in the red in January. The Nasdaq Composite (COMP), for instance, rose 1.4 percent, although it too gave back most of the gains.

Further, the track record of a down January is mixed. Chart 1 plots the annual returns for the S&P 500 going back 70 years, to 1951. The year 2021 is marked with a question mark. The data is divided into four buckets: (1) years that were up when January was up, (2) years that were down when January was up, (3) years that were down when January was down, and (4) years that were up when January was down. In parenthesis is the number of years corresponding to each bucket.

It turns out the barometer’s success rate is very high when the month is up. Out of the 70 years, there have been 42 years in which January was up. Out of those 42, the index went on to have a positive year in 37 of them; only five were down.

January was down in 28 of the 70, of which 14 ended up for the year and 14 down – essentially a coin toss.

January’s volatile trading helped form a monthly spinning top, ending the month right on a crucial trend line from last March (Chart 2).

Last March, after a five-week, 35-percent collapse, the S&P 500 bottomed on the 23rd. Through the intraday all-time high of 3950.43 on February 16, the large cap index rallied 80 percent! February traded similar to how January behaved. Through that high, the month was up 6.4 percent. Then, sellers showed up. When it was all said and done, the gains were cut down to 2.5 percent. In the end, a monthly shooting star was formed. Sellers are showing up.

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