The Bull Is Awake, But Will It Continue?

Image via Market Gauge

After 6%, 9%, and 12% run-up moves in the S&P 500, Small Caps, and the Nasdaq, respectively, the most important question is, “Does this positive market continue? Are we in for even better returns in the near future?

We don’t know, but we want to offer you a few different perspectives.

The January Effect

You may recall that in the last few Market Outlooks, we have addressed the January Trifecta … the Santa Claus Rally (SCR), the First Five Days (FFD), and a positive month of January indicates that we will see the “January Trifecta.” This signals that we are on much better footing with a high chance of a positive year.    See the chart below, which was also posted in a previous Market Outlook:

As goes January, so does the year. Since 1950 with only 7 exceptions over 72 years, when January’s performance (S&P 500) has been positive, the whole year has been positive. 

As you can see from the chart below from Ryan Detrick at Carson Research, January is the best performing month, and even more so in Pre-Election years.

We are in a “Risk-On” positive environment.

This could last a while longer, or the markets could suddenly stop in their upward tracks just like they did 4 times during 2022. So far, the Nasdaq is on a 4-month high and looks to have the most momentum of all the major indices. Don’t forget that the Nasdaq 100 index (QQQ) was down 33.0% for 2022. So a fast rebound is not surprising.

Remember, if you are down 33%, you have to gain 50% just to get back to even. Right now, the Nasdaq has made less than a quarter of the return required to recover its 2022 losses. However, currently, the index is experiencing a much-welcomed positive bias. See the chart below:

When January has been up more than 5% following a down year, the investing climate ahead has been promising. See the chart below:

Investors are playing “Catch-Up.”

There’s an interesting investor mentality that we have witnessed many times in the past. In the last few months of a big correction or bear market, fear, disgust, and other understandable emotions cause investors to run to the safety of cash and “pull the plug” on some or all of their investments.

Then, as they sit on the sidelines, the market behaves more rationally and moves higher.

Nothing improves market sentiment faster than a bullish trend.

As a result, those same bearish investors begin to “reload” and move back into the markets.

We see signs of more bullish investor behavior in the repeated pattern of the market opening lower on negative news, but then by the close, the market is up on the day.

Investors (including large institutions that are aggressively rebalancing) are beginning to put money to work again.

Ironically, after a big sell-off, investors often think there is way too much risk inherent in the markets when in fact, the opposite may be true:

The Nasdaq, which was down more than any other market last year, has recently experienced more positive price action. This suggests that speculators are coming back. Historically these kinds of patterns point to better future investment performance, as evidenced in the following chart:

The big mega-cap stocks are the largest contributors to Nasdaq’s price changes. Several of these were down big in 2022. Investors believed that these multi-national, dominant leaders could withstand a bad market. Such was not the case.

Investors bet that earnings and profitability would hold up. So far in this earnings season, several of these companies have cited lower earnings expectations going forward. Yet the market’s recent positive bias has favored many of these companies the most. Like a slingshot, more of the money has gone into these top components:

Will this bullish sentiment continue?

Again, we do not know. However, given the following few facts, we would still advise exercising caution and having a plan that considers the market’s downside risk. 

For us (and our clients), this means utilizing a strict multi-strategy discipline which we offer through our asset management firm MGAM (more about this towards the latter part of this Outlook).

Here are some important facts to remember as we head into February.

  1. Pushing up into resistance.

Nasdaq (QQQ), S&P (SPY), and Russell 2000 (IWM) are all pushing up into or through important long-term trendlines. We suspect there will be plenty of resistance on at these levels.

We’ll be looking for more confirmation to support a significant move higher, and on the lookout for any weakness given these are levels that the markets have retreated from in the recent past.

  1. We are in Earnings Season

Earnings time is always full of surprises. And it is not necessarily the pure numbers or whether the company has beaten earnings expectations that drive its stock’s price action after the announcement.

Often it is the conference call that comes right after reporting the numbers that gives analysts the true story. How many times have we seen a company’s earnings surpass expectations, the stock rallies after hours, and then the conference call creates a swift and downward reversal?

As we have reported in this column numerous times, earnings are affected by increasing labor costs, raw materials, interest rates, and other input costs.

Right now, investors are seeing these factors affect earnings and stock prices.

While many companies are benefiting from rising consumer prices which contributes to higher revenues, company’s profits are being adjusted downward.

This is going to have a dramatic effect on stock prices eventually. This is why we have said that the S&P could trade as low as 3200 or as high as 4400. See the S&P Profit forecast from FactSet below:

3. The Fed is meeting next week.

The US economy is cooling as the Federal Reserve would like. Unfortunately, the growth of the economy has not stalled. Yesterday the 4th quarter GDP came out above expectations at 2.9%.

Additionally, this past week the Fed’s preferred inflation measure, the PCE (Personal Consumption Expenditure) number came out at its lowest pace in more than a year (temporary workers declined due to seasonal factors). This will likely make the Fed downshift the size of its interest rates as expected when it meets this week.

Our view is if the Fed backs off its monetary tightening too soon, inflation could climb again.

Here are several reasons why we believe the Fed should continue being aggressive (and not pivot to a dovish stance):

    1. Inflation is still too high. Our experience is it could take several years to bring down to the Fed’s target.
    2. The labor force is still too tight. There are immense worker shortages which will continue to put pressure on labor costs.
    3. Rents in the US are still very high and putting pressure on inflation, especially in big cities like Phoenix, Denver, Miami, Dallas, etc. The rate of inflation in many of these cities is closer to 7-9% and not the 4-4.5% the media keeps reporting.

Everyone is looking for and hoping for a soft landing. It’s not likely to happen. The American economy does not go through a monetary tightening cycle like the one we are in, and land softly. Which is the next reason we believe you should be cautious about your investments right now:

  1. Many Americans are bracing for a recession.

A recent Morning Consult Survey found that 46% of Americans believe we are already in a recession. Another 25% are bracing for the start of one.

We’re not officially in a recession,” said Amanda Snyder, a finance reporter at Morning Consult. “But if people feel that their money is not going as far as it was or their income is shrinking, then they personally are experiencing a financial downturn,” she added.

This is the true meaning of Stagflation, and we believe it keeps pressure on the US economy, company’s sales and profits, and it may eventually find its way into the stock market’s performance.

  1. February’s historically weak performance improves in Pre-Election Years.

You may recall from last week’s Outlook that the S&P 500’s performance in February’s since 1950 has been positive 56% of the time but it has had a negative average return of  -.14%.

However, our friends at Stock Trader Almanac point out in the table below that February’s in a Pre-Election years have a much higher win rate and a modest positive average return.

After the big run-up we saw in January, we suspect the market will pause or digest some of the gains. See the chart below:


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