Welcome readers.  We hope you had a profitable and productive last week of January and first few days of February.

Freepik

 

The End of the Month Period.

The end of the month is a uniquely favorable period for investing.  A number of factors contribute to this, including 401k contributions getting invested, companies typically buying back their stock towards the latter part of the month, pension funds rebalancing their asset allocations, and some individuals having auto investment plans.

Combine end of month favorability and the continuation of a bull market that blasted off at the beginning of November when the Federal Reserve broadcasted upcoming rate cuts, and it is no surprise that the market remains in party mode. 

It is also earnings season (more on this shortly).  Couple the favorable positive seasonality with blowout earnings from several of the largest tech companies, and you have the recipe for the party to extend further.  But will it continue?  We will explore a few charts and commentary about the upcoming (election) year and what the current earnings season and market pricing may hold going forward.

Therefore, it is no surprise that the end of January and the beginning of February have, so far, been positive.

Did you know that MarketGauge utilizes a strategy that invests only 32% of the time in the markets and takes advantage of calendar and seasonally positive periods?  This strategy has a back-tested and partially real-time track record with over 8.5% a year return for 6 years with minimal drawdowns.

We also recently received a positive signal from one of our other investment strategies, Profit Navigator, and entered the market with a partial position.  The unlevered strategy has back-tested at over 17% a year with drawdowns of less than 40% of the S&P 500.  The levered strategy interestingly enough has back-tested at over 32% per year with drawdowns slightly less than just investing in the S&P 500.

 

Two important economic inputs this past week.

On Wednesday, the Federal Reserve Chairman, Jerome Powell, told the markets that there would be no change to interest rates, which fell in line with economists’ and market watchers’ predictions.  He also stated that it was unlikely that the Fed would lower rates in March.  That took some investors by surprise and resulted in an immediate sell-off which reversed course by day’s end and had little negative influence the remainder of the week.

The Federal Reserve continues to aim for the proverbial 2% inflation rate.  As we showed in last week’s Market Outlook (if you have not had a chance to review it, click here), inflation has come down at a rapid rate.  One of the reasons for inflation falling so fast is that the supply chain has been “fixed” and commodity prices have plunged.  A good illustration of this is the following chart:

 

Global commodity prices rose marginally for the first time in 9 months at the start of 2024 but reported supply shortages remain below long-run averages.  We think the Fed was acutely aware of this back in the fall when they announced several interest rate cuts in 2024.

 

The Fed’s Pause

As we stated above, the Fed’s pause was not a surprise.  December payrolls added 216,000, and the CPI, which measures inflation, came in at an annualized rate of 3.4%, well above the 2% target rate.  Then, on Friday, the jobs report was SHOCKING with an announcement that came in at 8:30 a.m. (before the market opened) with 353,000 new jobs added in January.  This was over 2x the expectations given that ADP announced their household report of only 107,000 new jobs earlier in the week.  The unemployment rate declined to 3.7% from an expected rate of 3.8%. Interest rates, which had been slowly coming down, reversed course and ended the day over 4% for the 10-year Treasury.

Who to believe?  We are not sure that the Bureau of Labor Statistics report of 353,000 could be accurate given that the ADP report was actually obtaining accurate information from households. Many believe the ADP report more accurately reflects the job market.  Also, the 353k number could include people who are working multiple jobs and being counted several times.

The positive number that was released on Friday (and may have been the silver lining) was the Employment Cost Index, which only increased to 0.9% and shows that labor costs are slowing dramatically.  This number suggests that employers are feeling less pressure to raise pay to attract and retain workers as wage growth slowed in the 4^th quarter of 2023.  These numbers show a possible reacceleration of the economy.

Conclusion on interest rates:  Last year, in this column, we commented frequently that we believed interest rates would stay higher for longer.  Now we continue to believe that the economy is not showing nearly enough signs of weakness to warrant the Fed to lower interest rates until later in the year.

We also remain concerned that inflation may reaccelerate, especially given the turbulence in the Middle East and the effect it could have on the price of oil.  The market has adjusted its expectations to only a 20% chance that we could see a March rate cut.  While June remains at a 60% chance, we wouldn’t be surprised, given the strength in the economy, if that rate cut is also pushed off a few months.

However, another point of view worth considering is that the Fed may wish to help the current administration get reelected (or feel the pressure to do so). There may be a high probability that they are going to cut rates mid-year to create easier financial conditions going into the election.

 

The Market Party lives on.

• The S&P 500 closed at an all-time high for the third consecutive week and is now less than 1% away from hitting 5,000 for the first time.
• Since the October low, the S&P 500 has closed higher in 13 of the past 14 weeks, gaining 20.4%. See chart below:

• There have only been seven other instances where the S&P 500 surged +20% over 14 weeks and then closed at a record high. Every one of these instances, the S&P 500 has been LOWER one month later, averaging a loss of -2.18%.
• Those pullbacks may have been good places to buy as 85% of the time, the S&P 500 was almost always higher three months later (6 out of 7 times). The chart illustrating this is below:

 

Is it a good time to put capital to work in the stock market?

Friends and clients always ask this question.  It is a good one.  Up above, we showed that after hitting a new all-time high after 14 weeks (and a 20% gain) the markets were lower 4 weeks later.  This may or may not happen this time.

Statistics point out that investing in the market after it hits a new all-time high tends to reap further gains.  Additionally, investing after a positive January has good follow-thru potential.

Even if it were not the best time to get invested, our strategies are intended to help minimize risk and rotate into more favorable areas of the market.

All of our strategies utilize disciplined risk management and if you follow our guidance, the instructions will help mitigate potential drawdowns if they were to occur.  Also, it is important to know that it is not a stock market but a market of stocks (and ETFs) and proper rotation and risk management have historically produced positive returns even in unfavorable periods like 2022.  So what might these strategies do in a good market?  

We want to illustrate a few of these concepts for you so that you can decide for yourself if you should put more capital to work.

Investing when the market hits an all-time high has demonstrated better returns.  See chart below:

 

Would the Fed consider cutting rates at or near all-time highs?

Yes, they have several times as we illustrate in the graphs below.  It is also likely that they end up cutting rates this year with the markets at or near an all time high.

Conventional wisdom says the Fed only cuts rates when there are problems in the economy.  However, if you look at history since 1980, there have been 20 rate cuts when the market was within 2% of the All-Time High.  Looking out from the first rate cut, 100% of those 20 instances the markets were higher a year later.  The summary is if the Fed does cut rates and the market is tracking close to an All-Time High at the time they cut rates, this would be bullish for the markets.  See chart below:

Looking back in time, with a couple of exceptions (1932, 2001, 2007), after the first rate cut, the stock market typically moved higher.  To break this favorable trend, you need a fairly disastrous economic backdrop to break this rule of thumb.  See chart below:

 

Is the stock market expensive or considered cheap?  Or appropriately priced as the headline above says, “Don’t Worry About Valuations”?

Thankfully, I have lived through enough different market cycles, good and bad, to know that the above opinion is ridiculous.  At some point stock markets can get expensive.  Based on historical valuations, the market today is expensive and stretched.  The party may be going on longer than expected.  But these “mania” periods can and do go on longer than expected.  (I have lived through several, and I am sure you have as well.)

Take a look at the below chart to compare the historical valuation metrics that are often used and what their current % above or below their long-term averages is today.

We have included a few other interesting metrics that have been provided by other research firms below:

Stock prices vs car prices.  Is 2024 a good time to either buy a used car or sell stocks?  Or both?

Here's something you might find interesting.  In looking at the chart below, you can see that the S&P 500's forward price to sales ratio is currently extended well above 2.5x, although it's not nearly as high as it was at the end of 2021 when the first post-COVID bull market came to an end.

What's noteworthy, though, is that the S&P 500 Equal weight index (which weights all 500 stocks equally instead of on a cap-weighted) has a forward price to sales ratio that's actually at the bottom of its three-year range and essentially at the same valuation it traded at in February 2020 just before COVID hit.  Translated: the mega-caps have higher valuations than the rest of the market.

 

January was a positive month.  And that bodes well for the remainder of the year based on history.

January ended on a positive note.  Here are the returns from the end of 2023 to January 31 and then to this past Friday, February 2, 2024:

You can see how much the 2 days tacked on (Feb 1 & 2).  The one problem with the above numbers is the negative divergences of the small cap stocks, which are commonly referred to as “the soldiers.”  The generals (mega caps) are working hard, especially stocks like Meta, Amazon, Nvidia, and Microsoft (4 of the Magnificent 7), but the small caps have not recently been participating.  Some of this is due to higher interest rates and borrowing costs that do not negatively affect the Mega Cap stocks, which are flushed with cash.  Small Cap stocks are also telling investors that they are concerned about the economy and sustaining high growth rates.  This will need to be resolved, or it will likely pull the rest of the market down.

Thursday, Meta, Amazon, and Apple reported earnings.  Meta’s had reduced headcount during the past two years while also increasing revenue from incorporating AI.  This helped it blow away earnings expectations.  Meta exploded higher.  Other mega cap stocks like Google barely missed earnings expectations and sold off.  See this past week’s heat map on the diversion between some of Wall Street’s favorite stocks.

An investor cannot underestimate the impact of a $1 trillion stock like Meta adding 20% in one day, something that has never been done before.  See the following chart:

 

Up January vs Down January.

Our friends at Stock Trader’s Almanac recently provided information showing just how good an up January versus a down January portends for the next 11 months.

An up January has much more outperformance versus when it’s down than any other month in the year looking out 11 or even 12 months.  Since 1938 when the S&P 500 was up in January the next 11 months average a gain of 11.6%.  When January is down, the next 11 months average plummets to just 1.2%.  No other month comes close to these levels.   See illustration below:

Given that the S&P 500 was positive for January, we can now evaluate the January Indicator Trifecta developed by Yale Hirsch in 1972.  This Barometer has an 83.8% accuracy ratio.  The indicator adheres to the propensity that as the S&P 500 goes in January, so goes the year.

Their January Indicator Trifecta (shown below) combines the Santa Claus Rally (SCR), the First Five days early warning system (FFD), and the full-month January Barometer (JB).  The cumulative effect of all 3, as the Stock Trader Almanac points out, is considerably greater than any of them alone.  It was 100% accurate last year (2023).  However, this is only the 4^th time that the SCR and FFD were down (see below) and the JB was positive.

Given the January Barometer was positive this may help instill optimism in your 2024 investing plan. See chart below:

Hopefully we have provided some historical information and views that you can integrate into your overall investment plan for the remainder of 2024.

Given our expectations for enhanced volatility this year, we suggest our subscribers, as well as asset management clients, utilize a blend of our proprietary investment strategies, remain diversified, and take advantage of proper risk management in your overall investment portfolio.  If you need some assistance, we are here to help you!!!

We wish you a safe and peaceful upcoming week and good luck in your investing.  Thank you for reading the Market Outlook.

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