A Cautious Start

A Cautious Start

January 10, 2024

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I always get a kick out of the annual projections from all the talking heads and research departments on Wall Street. I mean think about it. They are all reading the same tea leaves, so how are they usually so separated in what they project for year-end S&P 500 targets? The reports tend to be pretty and the public eats them up, but I find them to be of absolutely no practical value. So much can and usually does happen throughout the year that expecting to be able to decide in advance what the financial markets will do and what will outperform or underperform I think should be left at the bar during the cocktail parties.

In my opinion, interest rates and interest rate expectations are the primary short-to-intermediate-term driver of stocks, and in the longer term it is all about earnings. Rising interest rates tend to be viewed by the market as negative for equities, while falling interest rates are bullish for stocks; and interest rates have mostly been on the decline since their high point in late October of last year. To be a little more granular on this point, interest rates are a reflection of expectations of the economy, and if the expectation is economic softness coupled with lower inflation expectations, then rates should be on the decline. Now, this may be true, but we need to be careful that they don't fall so much that it either infers a recessionary trend (negative for earnings) or they fall so much that it gives the inflation boogie man a chance to get back on his horse. 

So, what do I pay attention to besides interest rates and earnings then? Well, basically two major things:

  • Market estimates based on the "equity cycle."
  • The current state of the markets based on the most recent history. Is the broad market in an uptrend, a downtrend, or is it at a past high or low point?

When looking at "equity cycles," I try to measure the probabilities of expected outcomes based on where we are in cycles. By cycles I mean the presidential cycle, or the post market low point cycle, or the length of time in an ongoing uptrend cycle. Currently my analysis indicates the S&P 500 has entered year two of a bull cycle that started in October of 2022 after coming off the dreadful 2022 decline. This is developing concurrently with an economic cycle that didn't fully reset in 2022 due to the massive liquidity I mentioned almost every week last year. I believe if it weren’t for the $5.5 Trillion that was sloshing around the economy to provide unabated purchasing power, we would have most certainly sustained some level of recession.

 To quote Ari Wald of Oppenheimer Technical research'

"Looking at bull cycles following a recessionary vs. non-recessionary bear, we've found the latter are usually steadier (lower year-1 returns followed by higher year-2 returns) and last just as long (median of 32 months). The 37% gain since October 2022 is on par with the typical returns following a non-recessionary reset, and the median return between months 15 and 27 (December 2023 - December 2024) has been 13% which is the basis for 2024 expectations."

Ari goes on to say that the last time there has been a negative election year (again, another cycle-the presidential cycle) was in 1948! Below I show both the table of expected returns following the first cycle data mentioned:

Of course, we need to be cognizant of major crosscurrents currently in place;

  • two high-profile wars
  • a slowing economy
  • a US government ready for a shutdown
  • pre-election positioning by both parties
  • a pivot of interest rate policy
  • chances of a recession


Pretty meaty roadblocks to be sure! Thinking back a bit, in late 2021 the Fed made it clear that there was no way they could rein in inflation without raising interest rates and raise them quite aggressively. This was a new playbook, far different from the zero-interest rate policy they had been working under. So, the markets subsequently swooned from November 2021 until October 2022. Then it bottomed out as the actions of the Fed seemed to be taking hold and having the desired effect on inflation. Then the markets bounced, but only bounced right back up to the old highs. Yet, most stocks are still not close to their respective highs as the S&P is. Here is the picture of exactly what the last couple years has been like. Note the high in 2021, the low in 2022, and the high just a couple of weeks ago:

With the Fed now widely expected to cut interest rates this year; it makes one question what kind of "new environment" we are transitioning into. As I said above, I do not for a second expect that I can predict market outcomes but given the cards the current market is being dealt with, and how these kinds of hands have played out before in similar cycles, we can get some clues. I know consensus is basically saying it is all smooth sailing, but I bring to attention just this last week as an example of the folly of such expectations. After nine weeks of consistent uptrend and all the wonderful year-end, Santa Claus rally talk, profit taking hit the market like a starting gun the first trading day of 2024.

Many are counting rate cuts coming to the rescue and reinvigorating the bull, but just as this is what is “expected,” we got some labor numbers last week that were far from what would reflect a slowing economy and to me, most certainly puts into question that this first rate cut will happen as expected in March. 

This sort of brings me back to the "election-year cycle." Election years typically are quite strong as the incumbent party wants to make themselves look as good as possible going into the election with hopes of reelection. As I had said above, the last time the S&P saw a negative election year was 1948. This being said, the short-term profit taking in the first week of 2024 is probably not quite over, and some additional volatility to burn off the ether of the nine-week rally could plausibly be expected in the first quarter, but the year still seems poised for a positive outcome. In the chart below, the blue line is what the Dow Jones Industrial Average does on average during election years. Notice that it seems to build its energy in the first quarter and then get itself in gear into the year-end. 

The last point I would like to make is the current action of the Small-Cap companies as they have been trying to play catchup to their Large-Cap brethren. Below is a chart of the Russell 2000 (Small-Cap Index) and below it is a chart of the Russell 2000 relative to the S&P 500. As can be seen, the Russell has been in a sideways move since its decline into the beginning of 2022, and for the last two years really hasn't been able to get its motor running. Many are choosing to say that this has been long enough, and it is time for it to lead the broader S&P. As can be seen in the lower portion of relative performance, the Russell continues its underperformance and I for one would prefer to be late to this party and more confident than early and continue to be sorry. 

The last picture for you to study is the action of the S&P 500 Index relative to the NYSE stocks above their 200-day moving average line. I look at this to see what has been happening relative to the high and low points in the S&P 500. Note that the number of stocks above their 200-day line was falling when the S&P hit its high point in late 2021. This is called a negative divergence. Then, throughout the advance in the last 15 months, it has held its own but of late seems to be saying that it could be prepared to expand as earnings and further advancing markets would support. Will it happen? I again would prefer to wait and see some levels of confirmation before believing it to be the case, but for now, this correction the markets are experiencing to start 2024 has been measured and seems to reflect typical beginning of the year profit taking vs. a reversal of the uptrend. Stay tuned!

Please feel free to reach out with any questions you may have as we are all here at the ready! Once again, we wish you all a very Happy New Year!



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The Standard & Poor's 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

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