/ January 06 / 2025 Preview & Predictions
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Monday:
Factory Orders MoM (-0.3% exp.)
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Tuesday:
ISM Services PMI (53 exp.)
JOLTs Job Openings (7.70M exp.)---
Wednesday:
Initial Jobless Claims (217K exp.)
FOMC Minutes
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Thursday:
Various FED Speakers
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Friday:
Non Farm Payrolls (160K exp.)Unemployment Rate (4.2%)
Michigan Consumer Sentiment (73.9 exp.)
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Monday:
N/A
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Tuesday:
Cal-Maine Foods CALM
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Wednesday:
Jefferies JEF
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Thursday:
N/A
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Friday:
Delta Air Lines (DAL)
Walgreens Boots Alliance (WBA)
Constellation Brands (STZ)
Off to a Disappointing Start
In our last edition of the Weekly Preview Newsletter, we discussed how the stock market was oversold enough to elicit a bounce, and how conditions were set up for a perfect “Santa (Reflexive) Rally”. As it turns out, Santa delivered investors a “lump of coal” this year. The price action remained poor, with persistent selling pressure and weak momentum being prevalent in the last part of December.
There’s no way to sugarcoat the recent market performance. While 2024 was a stellar year for equities, with the S&P 500 generating 20%+ returns, around 3% of that performance was shaved off in the closing month. Small caps fell apart after attempting to “make a comeback,” and overall market breadth declined. For that matter, all major risk assets closed lower for December, to various degrees.
Despite the impressive rally on Friday, the market ended up short around -0.5% to generating a positive Santa Claus Rally signal.
However, all hope is not lost for 2025!
“Since 1950, when all three January indicators (The Santa Claus Rally (SCR), First Five Days (FFD) and the full-month January Barometer (JB)) are up, the S&P 500 was up 90.6% of the time (29 out of 32 years) with an average gain of 17.7%. When one or more of the Trifecta is down, in this case, the SCR, the year is up 59.5% of the time (25 of 42) with a paltry average gain of 2.9%.” – Stocktraders Almanac
With a positive SCR signal missing, the statistics are still positive, but much less bullish:
“Of the 16 down SCRs since 1950, 11 years have been up and 5 down, but the average gain is a tepid 6.1%.“
Out of all the year-start omens, the January Barometer tends to be the most reliable (if January sees gains, the year is likely to end positively - or so says the theory). The stats are there to back up this indicator. Since 1950, the S&P 500 has posted an average annual return of +16.8% during years that included a positive January, with 89% of years posting positive returns. In contrast, when the index traded lower in January, annual returns dropped to -1.7%, with only 50% of occurrences yielding positive results.
The good news is that the market is now decently oversold on multiple metrics. This condition creates a reasonable technical set-up for the month of January, which should see an improvement in returns. Sentiment has recorded a “Fear” reading for about 2 weeks, declining just short of “Extreme Fear” (or an outright panic). It’s uncommon for sentiment to remain in extreme territory for more than 2 weeks, so a reflexive bounce has good odds of happening.
The market’s breadth has also been decimated, with a majority of stocks now trading both below their respective 20 and 50-Day moving averages. At the 200-Day interval, breadth is stable and has not declined further (contrast with the highlighted period, when 200-DMA breadth deteriorated in lockstep with all of the other measures). All things being equal, this is a bullish interpretation, suggesting that the market’s overall positive disposition remains unchallenged. So far, the decline looks like a regular correction and profit-taking process, with nothing more sinister lurking under the surface.
In what is possibly the most bullish sign, Dollar Transaction Volume has declined to very low readings, as many traders and investors were on holiday, leaving only the machines and algos to move the market during the past 2 weeks.
Such a low volume on relatively lower prices is BULLISH, as it suggests that most excesses have now been reversed and everyone who needed to sell has already sold.
When analyzed through the lens of a longer timeframe, the market remains expensive despite the near term decline. Our base case assumption for the end of 2025 (middle of the extended trading channel) is set to $640, a somewhat conservative Price Target that leaves around ~8% upside from current levels. This barely justifies a 4% equity risk premium over the 4% risk-free treasury yield.
In other words, unless our Price Target is too low, there is ample space for the decline to continue in the medium term, at least from a fundamental perspective.
Just to recap, here are the predictions made by Wall Street’s biggest banks and sell-side analysts at the end of 2024. The median Price Target stands at 6.600, corresponding to about $660 on SPY. Our call is at the lower end of the table, similar to the view held by UBS.
In our view, earnings growth remains the main driver of stock returns in 2025. Over the last year, the companies that dominate the market capitalization weighting of the S&P 500 index created a substantial outperformance over the index. The only company to record lower returns than SPY was Microsoft (MSFT). This outperformance can be completely explained by looking at the performance and the Earnings Growth charts, as the correlation is fairly obvious.
Earnings Growth TTM - 31% Group Median / 10% SPY
2024 Returns - 54% Group Median / 24% SPY
Present Price to Sales versus MAX Price To Sales (2Y)
Our Trading Strategy
For now, we own a healthy risk allocation that does not need increasing. We will perform a full portfolio review on Wednesday and decide on necessary adjustments. For investors who are not yet at target allocation for their equity position, now is as good a time as any to place their bids and become buyers. There is enough upside to justify long positions.
The risk lies in the medium term, with any factor that may dent the (very) high expectations for Earnings Growth. Any event that causes a significant decline in Earnings Growth expectations is liable to cause a “reversion to the mean” for valuations, which is not going to be pretty. These historically high growth rates and valuations need at least 3 ingredients to exist:
Economic growth more robust than average;
Wage and labor growth must reverse to sustain historically elevated profit margins;
Interest rates and inflation must reverse to very low levels.
All of these are certainly possible, but are becoming more improbable, hence our cautious approach.
Conclusion: the market needs to find its footing and rally. Absent that, we will need to look at increasing our cash position and taking a more defensive stance.
As we start a new year, it is worth repeating the rules that kept us out of trouble and profitable. Also, if you haven’t done so already, check out the pre-release version of our new app here (some screenshots in this article were already generated using that!).
1. Cut losers short and let winners run. Scale up into positions that work, rarely vice-versa. Refer to our Removals guide.
2. Set actionable goals. Decide the proper position sizing, Profit Taking and Stop Loss price for each position, when doing your investment planning. Do this when the market is closed. In the “heat of the moment”, during the live session, consult your pre-set plan. Use the Portfolio Tracker to monitor positions and risk - now available in the new app!
3. Abstain from emotional mistakes. Emotionally driven decisions void the investment process. Use the Sentiment indicator to avoid buying in Greed and selling in Fear.
4. Never let a “trading opportunity” turn into a long-term investment. Until your thesis is proven correct, a position in your portfolio is “just a trade”. Many traders become “long term investors” when their positions under-perform. Refer to rule #1.
5. An investment discipline does not work if it is not followed. “Just do it” - easier said than done, but focus on the process rather than returns, and profits will eventually materialize.
6. “Losing money” is part of this game. You should not be investing if you are not prepared to take losses. Refer to Rule #2 to understand the risk you are taking.
7. Strive for a “70% win rate”. No strategy works 100% of the time. There’s no “magic bullet” when investing. However, doing research, managing risk and emotions can be practiced every day and will lead to successful outcomes given time.
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!