/ December 11 / Weekly Preview
-
Monday:
N/A
Tuesday:
Core Inflation Rate YoY (4.0% exp.)
Inflation Rate YoY (3.1%)
Wednesday:
Fed Interest Rate Decision (pause expected 98.4%)
FOMC Economic Projections & Press Conference
Thursday:
ECB Interest Rate Decision (pause expected)
Initial Jobless Claims (223K exp.)
Friday:
NY Empire State Manufacturing Index
Industrial Production MoM
S&P Global Manufacturing PMI Flash
-
Monday:
Oracle ORCL
Tuesday:
N/A
Wednesday:
Adobe ADBE
Thursday:
Costco Wholesale COST
Lennar LEN
Friday:
Darden Restaurants DRI
Is there anyone left to Buy?
Markets struggled to advance early last week, but a series of weaker than expected economic reports boosted odds of rate cuts in 2024. In turn, equity markets responded by extending recent gains to fresh year-to-date highs. A combination of overbought conditions and excessive positive sentiment kept the bullish advance from going even further and has us asking the question “Is there anyone left to buy?”.
Apparently… there is no shortage of bidders at this juncture!
A much hotter than expected jobs report on Friday did not tank the market as many bears would have hoped. Despite the expectations-beating headline numbers (3.7% unemployment and 199K jobs) the report marked the second consecutive month with job additions below the average monthly gain of 240,000 observed over the past year, signaling a slowdown in the labor market. Job gains were powered by government payrolls (49K increase) while retail trade employment declined by 38K. In the context of weaker than expected job openings (8.73M according to JOLTS data), the Fed has no business raising interest rates at this juncture - a rate hike is effectively priced out for 2024.
Against this rather benign outlook, markets reacted by eventually grinding higher. SPY took a step closer to our fundamental year-end price target of $467, leaving just 1.5% of potential upside. Any corrective process should be well contained by immediate support at $447, some -2.8% lower.
SPY Analysis
The MACD Signal has turned to a SELL from a very high reading, suggesting there is little upside to be had;
With risk-reward skewed to the downside in the near term, we could also be led to believe that the “Santa Rally” has already been priced in, given November’s stellar advance. Per Yahoo Finance:
“Historically, volatility tends to contract at the end of December, paving the way for predictable year-end gains. But this year, November’s gangbuster returns may have brought forward an early Christmas for investors. Stocks have had three principle catalysts over the last two years — inflation, jobs, and the Federal Reserve — and all three are on the docket over the next week. Whether bullish or bearish, markets could get quite interesting in what is normally a sleepy time of year.”
The Santa Claus rally is a term that defines the unusual high returns experienced during a particular 7 day trading period (the last five trading days of the current trading year and the first two trading days of the New Year). The actual Wall Street saying is “If Santa Claus should fail to call, bears may come to Broad & Wall.” - meaning that if this 7 day period is negative, the following year brings negative returns as well.
The stats baking up this “myth” are anything but. Stock Trader‘s Almanac notes:
“The stock market has risen 1.3% on average during the 7 trading days in question since both 1950 and 1969. Over the 7 trading days in question, stock prices have historically risen 76% of the time, which is far more than the average performance over a 7-day period.“
This unusual seasonal pattern has a couple of fundamental underpinnings. First, professional managers tend to prepare portfolios for reporting (also called “window dressing”) and buy the hottest stocks. By definition, the “hottest stocks” are those that have already performed best, leading to a continuation in momentum for these names. Secondly, this is a popular time to cut losers short for tax loss harvesting purposes (further creating selling pressure on stocks that have already under-performed).
This behavior tends to create an environment where “trend following” prevails versus “range trading”. If we were to go by our Sentiment indicator (which has worked 100% of the time in the past 2 years as a range trading instrument), a SELL signal has been triggered for the December 1 through December 15 period.
Sentiment is a contrarian signal; it works best at extreme inflection points; once 2 standard deviations are exceeded for the stocks we monitor, a signal is triggered for the next 2 weeks; the latest such signal (SELL) was given on December 01, on an “Extreme Greed” reading; our only concern is that no indicator has a perfect track record, and this indicator has worked exceedingly well during the last 2 years;
November and December are also great months for stock buybacks. As the year wraps up, corporations have a clear picture of their current financial positions and can use stored cash to execute buybacks. This year, the buyback frenzy hit a historical high, as BofA Global Research points out:
However, the buyback window just closed on Friday, eliminating another source of liquidity from the market through year-end. Combined with exuberant sentiment, this environment leaves the market vulnerable to a reversal over any kind of disappointment (or for no other reason at all other than profit-taking).
With 2 key catalysts coming up later in the week, the probability for disappointment is rather high. The CPI report on Tuesday is expected to show headline YoY inflation at 3.1% and core inflation at 4.0%. Any upside in these figures will likely be met with a selloff in both stocks and bonds.
On Wednesday, the Fed will most likely decide to keep interest rates on hold, during the last FOMC meeting of the year (98.4% odds). Any perceived hawkish commentary during Fed Chair Powell’s press conference following the decision also has an outsized probability to disappoint. Bond positioning is similarly stretched to equities as well. Look at TLT’s chart with support and resistance levels highlighted.
Our Trading Strategy
We are always trying to answer the question “how much of the narrative is currently priced in?” While it depends on what narrative exactly you chose to focus on (see our Quarterly S&P 500 Market Outlook for various scenarios) the basis for making investment decisions remains the same:
Calculate the expected return from current valuation levels;
Determine potential downside if things “go wrong”;
Position accordingly if the upside exceeds the downside and vice-versa;
Given our assumptions derived from the aforementioned article, a 2024 year-end price target for SPY could be anywhere between $470 (base case scenario) to $508 (the optimistic scenario). You can find the theoretical upside / downside on the platform Dashboard calculated every day.
Only the optimistic scenario leaves any kind of decent upside at current prices. If our outlook is correct, an investor would do better if allocated for 1 year in short term treasuries which yield 4.7% - 5% at the moment, rather than initiate a new position in SPY.
So… “how much of the narrative is currently priced in?” - everything leads us to believe that “a lot is currently priced in”.
Our job as investors and managers of risk is to protect capital from short term destruction, while positioning correctly for the optimal risk-reward opportunities. At the moment, there is no need to become overly defensive and bearish. However, the plan is to slowly reduce portfolio exposure in a manner which allows for some extra capital gains to be achieved, while downside is reduced.
Types of actions that can be taken to achieve these goals include:
Selling covered calls on current investments
Swapping single stock positions for broad thematic ETFs (eliminating concentration risk)
Selling laggards and losers (if they haven’t already rallied with the market so far, what happens to these positions in a downturn?)
Tightening up stop-loss levels to technical support
Raising extra cash (not “sell everything and go to cash”)
Look out for Trade Alerts in your inbox this week as we adjust our live portfolio accordingly.
Signal Sigma PRO members will be notified by Trade Alert of any live portfolio changes (if subscribed). If you’re not on this plan yet, you can get a free trial when you join our Society Forum. If you need any help with your trading strategy (or would like to implement one on your account), feel free to reach out!