Broker Check

A Normal, Healthy Pullback

| January 16, 2024

The popular news media would probably classify 2024 so far as a “rough start.” Stocks began flat after 2023 ended sharply up. Does that mean this year will be more challenging than expected?

Our readers know we love data, so let’s see what history shows regarding the first five days of trading in any year, which can provide insight for the full year. The first five trading days of 2024 finished on Jan. 8. To end 2023, the S&P 500* closed at roughly 4,770. On Jan. 8, it closed at 4,764.

Is this a signal or a chance at a do-over?

Looking at the past 20 instances of being nearly flat for the first five trading days of the year, we think this is a do-over, especially considering the countervailing forces that created rotational action. Also, only 1957 and 1974 experienced double-digit losses after a flat first five days, and both were recession years:

So, if we don't have a recession (which we don't expect), historically it seems markets can still produce double-digit gains this year. That said, our hunch is those gains will mostly be in the second half of the year (more on that later) after we touch all-time highs early in the year.

More idiosyncratically, we should point out that outsized amount of 2024’s strength will likely come from technology once again. We think Wedbush technology analyst Dan Ives is among the best in the business. He highlighted three key reasons for tech growth:

  1. Artificial intelligence goes mainstream.
  2. Cybersecurity budgets rise sharply.
  3. Enterprise software spending continues to be strong.

Ives believes there's as much as 20.0% upside to top line earnings and value expansion on higher growth due to mergers and acquisitions within AI and cybersecurity. Such growth will likely boost the tech sector to become half or more of the S&P 500’s market capitalization as tech continues its most recent parabolic growth iteration:

In conjunction with the flat start to the year, the December consumer price index came in basically as expected. Leading up to that report, interest rates ticked up as bonds were anticipating a hot “core CPI” relative to the 0.3% consensus. But we think the market already discounted a hot CPI expectation in the first five days of the year because stocks didn’t budge much after the final December 2023 print, despite some initial volatility, then climbed in subsequent trading.

Slight price upticks aside, the fact remains that inflation’s glide path is continuing lower, as we’ve discussed several times. This trend continued in the most recent CPI, contrary to the popular media narrative, as the price upticks came merely from autos and more specifically auto insurance as insurers were still playing catch up to last year’s losses.

Thus, with interest rates expected to decline at some point, we wouldn’t be shocked to see new all-time highs soon, followed by the “reaction near highs” consolidation we mentioned last week.

Laggard Love

After digging further into the data, we think the early 2024 market action is akin to a “hangover” after a frothy end to 2023 rather than a change in the overall trend. As of this writing, here’s what a “market hangover" looks like:

Just six of the 34 indexes above are positive, and they’re mostly defensive. Compare that to what we saw from the Oct. 26, 2023, lows – the departure is obvious:

Looking above, 29 of the 34 U.S. indexes produced double-digit returns. Perhaps investors started this year by taking a breather from partying? Thankfully, we have data to help us know where we are and where we might go.

Let’s start with the trusty Big Money Index (BMI) from our friends at MAPsignals. The BMI is a 25-day moving average of netted buys and sells by “big money” professional investors. It’s been overbought since mid-December. Does the BMI show whether 2024’s first week was a consolidation or scheduled dump?

Remember, the BMI can stay overbought for a long time. What really matters is when it first falls from overbought territory, which means selling is ripping through the market. But even with indexes decreasing, the BMI is staying flat:

Why? Looking deeper at unusual trading volumes, we should expect a bump in volumes after the slow year-end holidays as portfolio managers reposition as investment companies require capital deployment (managers don’t get paid holding cash).

There has been a bump in unusual activity (chart below). But is it buying or selling?

There hasn’t been much “big money” selling in stocks, and just average buying:

Nor has there been much “big money” selling in exchange-traded funds (and minimal buying):

Taken together, this indicates sizable trading, but no new highs or lows. That means there’s likely a rotation out of leading sectors and into lagging ones. To confirm, we examined the VanEck Semiconductor ETF (SMH)# as a proxy, which fell 6.4% in the first week of trading after being up 32.0% in 2023’s last quarter alone:

Even though the price dropped, there were no red bars of unusual “big money” selling on the far-right side (the most recent red bar is from October 2023). This indicates a normal, healthy pullback, not a change in trend.

Furthermore, the MAPsignals sector ranks so far this year show how the most unloved sectors of last year are leading. This supports rotational rebalancing by institutions and investment funds into 2023’s laggards:

Interestingly, MAPsignals sector rankings reset annually, which is particularly useful in election years. See, since 1980 the S&P 500 has returned 10.3% annually, but the first quarter tends to lag the rest of the year:

However, 2024 is an election year. Typically, stocks get sold ahead of an election and bought coming out of one. This makes sense as investors hate risk and uncertainty early thus preferring to sidestep surprises.

Since 1980 there have been 11 presidential elections. Our friends at MAPsignals did a study that showed stocks fall an average of 1.5% in the first quarter of election years versus the usual 2.1% gain since 1980:

However, in those same election years, the remaining quarters average a stellar 8.1% return. So, this data tells us the rotation and slight dip to start 2024 are right on schedule, historically.

Thus, we remain bullish for 2024. Remember what the great Mark Twain said, “If voting made any difference, they wouldn't let us do it.”

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* The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.

# Neither Cornerstone Financial Services, LLC, nor Daniel Milan personally own SMH.

Securities sold through CoreCap Investments, LLC.  Advisory services offered by CoreCap Advisors, LLC.  Cornerstone Financial and CoreCap are separate and unaffiliated entities.