/ January 13 / Weekly Preview
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Monday:
N/A
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Tuesday:
PPI MoM (0.3% exp.)
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Wednesday:
Core Inflation Rate YoY (3.3% exp.)
Inflation Rate YoY (2.8% exp.)---
Thursday:
Retail Sales MoM (0.5% exp.)
Initial Jobless Claims (214K exp.)---
Friday:
Building Permits Prel (1.46M exp.)Housing Starts (1.32M exp.)
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Monday:
KB Home KBH
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Tuesday:
N/A
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Wednesday:
JPMorgan Chase JPM
BlackRock BLK
Goldman Sachs GS
Wells Fargo WFC
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Thursday:
UnitedHealth Group UNH
Bank of America BAC
Morgan Stanley MS
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Friday:
SLB SLB
Regions Financial RFState Street STT
Consolidation ahead of Q4 Earnings Season
Last week, we were discussing the market’s poor overall performance and how various year-start indicators have performed historically. Out of the 3 major signals, the January barometer is the most important, but we’ll only be able to assess that at the end of the month.
In the meantime, before we reach the full month of January, the market must pass the first five days test. As of Wednesday, Jan 8, which concluded the first five trading days of January, that market did generate a positive return, rising about +0.8%.
As we noted last week, it’s these two January indicators that have historically set the tone for the year, and their statistical significance is impressive.
Since 1950, the S&P 500 has posted net gains during the first five trading days of the year on 47 occasions. In 39 of those cases, the index ended the year higher, reflecting an 83% success rate for the "first five-day theory." However — out of the 74 completed years since 1950, the S&P 500 has recorded full-year gains 73% of the time, meaning that the indicator fails as a bearish prognosticator. In the 27 years when stocks declined during the first five trading days of the year, the S&P 500 still ended the year with gains in 15 of those instances. In other words, the indicator has only a 45% accuracy rate when forecasting full-year losses.
Additionally, history suggests that some of the market’s very best years actually started on the back foot. For example, the S&P 500 rallied 21% in 1991 despite losing -4.6% of its value during the first five days of that year. Currently, SPY is recording a -4.5% drawdown, with the high watermark being set in mid-December.
For investors, these calendar-based indicators can provide a sense of psychological reassurance, especially in times of uncertainty. At the moment, we are traversing one of these periods, when an increase in volatility is pressuring the stocks and bonds asset markets.
This week, it looks like the consolidation is set to continue. The S&P 500 tumbled on Friday as a hot jobs report dashed hopes for further Fed rate cuts. There were no Factors in the green, as small caps (IWM, -2.2%) got disproportionately hit by the jump in yields.
Several factors explain the recent period of market weakness. First, the markets were technically overbought entering December, trading (way) above current moving averages, and with little fundamental upside. This created conditions ripe for a correction or consolidation, though a catalyst was necessary to trigger it.
Eventually, the catalyst arrived in the form of a “hawkish” FOMC statement on December 18’th that reduced the number of expected rate cuts in 2025. This triggered a rise in bond yields which was accentuated recently by stronger-than-expected economic data. The Federal Reserve’s subtle change in tone, coupled with an exuberant and overbought market, made the subsequent consolidation somewhat predictable. As is often the case when markets stop climbing, bearish headlines have increasingly dominated media coverage. Recently, this trend has persisted, further amplifying selling pressure in the markets and generating a wave of persistent negative sentiment.
On that note, sentiment has now officially dipped into “Extreme Fear” territory, with the number of stocks “Oversold” reaching 2 standard deviation extremes. We can now confidently state that the consolidation over the last few weeks has fully reversed the overbought and deviated conditions from early-mid December. Usually, these bouts of extreme fear last for about 2 weeks on average, so it’s entirely possible we are at the start of the consolidation process rather than at the end.
With the recent lows failing to provide adequate technical support, SPY has now broken to the downside. The next important support level stands at $564, coinciding with the 200-DMA and the July 2024 peak (just before the “carry trade” correction). If the market reaches that level, it will likely be oversold enough to provide investors with a counter rally reduce risk into. Investors should be fully risk-reduced if the market starts breaching these levels.
If the market then rallies and fails, the next steps will start to become more critical, as that means that we are dealing with more than just a regular “garden variety” correction. As a reminder, SPY’s maximum drawdown over the last 2 and 3 years stands between -10.2% and -24.3%.
Although such a decline is inevitable at some point, there is no assurance that a significant correction will occur this year or next. For market valuations to reverse meaningfully, a specific event or catalyst would need to disrupt earnings expectations. With valuations already elevated, such an event could trigger a notable price adjustment. Monitoring market breadth and credit spreads will help determine whether the current consolidation is merely a pause or the start of a more substantial correction.
On the market breadth front, we are starting to see the beginning of some concerning deterioration, especially at the 200-DMA level. We’ll take this as an early signal for now, that can preface a more substantial decline.
The investment-grade bond to AAA spread is near its lowest level and is currently not indicative of market stress (2020 covid crash included in graph for reference)…
…but the Dollar Transaction Volume is there to suggest that there are considerable sellers putting pressure on prices at the moment and “confirming” the dip.
Our Trading Strategy
A disciplined approach to risk-taking becomes key in 2025. After a prolonged period of bullishness, it’s only natural to face eventual declines. While 2025 presents its share of challenges, the solution is not to abandon the market altogether. Instead, investors can take practical steps to navigate these uncertainties.
”Uncertainties” are always present in the stock market and are a function of doing any kind of predictive analysis. The trick is to not be either overly aggressive with risk exposure, nor be suckered into a “loss aversion” mentality. The next bear market may or may not be silently lurking around the corner. We simply need to walk a fine line and respect our indicators, levels and strategies.
The week ahead marks some key economic reports in the guise of PPI on Tuesday and CPI Inflation on Wednesday. The market seems to have made its mind up that these will come in hot. Additionally, the official start to earnings season happens on Wednesday, as JPMorgan Chase and other financial mega-caps report earnings. Normally, earnings season should provide a lift to prices, as results generally “beat” consensus and headlines sound optimistic.
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