It happened! We expected the market to hit an all-time high at some point in January and it did on Jan. 19.
Historically, there was not a single instance where the S&P 500* fell 20.0% then subsequently got within 1.0% of an all-time high without actually hitting a new high at some point. The longest it had taken in the past was 21 days. So, after last year’s big pullback, we were confident enough to call for new highs by the end of January (and they arrived early).
Some will argue the outlook for stocks is bearish due to the all-time high, especially after bouncing back from falling 20.0% or more during 2023. But that bearish narrative doesn't hold up to historical data. For example, after wide performance variations, equities are higher six months later in all 11 instances (with a median gain of 8.0%), and in 7 of 11 instances stocks were significantly ahead after 18 months:
Notice the biggest dip after the new high came in 2007, which reflects the financial crisis of the time. To us, that means it will take a Black Swan event or recession to crimp the bullish narrative.
That said, even though the market hit new highs, we’re seeing recent overall investor flows to be negative (more on that in a bit). Some institutional investors are being risk averse, bothered by the slight rise in interest rates, recent hawkish comments from the Federal Reserve, and new reservations around small-cap stocks:
Rest assured, that doesn't change our base case for the markets overall (and small-cap stocks specifically). We think investor flows will turn positive for the full year of 2024, especially when money market yields decline after the Fed begins interest rate cuts.
Yet, the short-term outlook could be bumpy. Taking a broader view, we still think stocks will constructively improve in 2024 (especially the second half) for these reasons:
- Inflation is still trending lower.
- Overall, the Fed is dovish and turning more dovish (despite recent comments).
- Pent-up demand for housing and corporate capital expenditures.
- Valuations for non-FAANG stocks are low, sitting around 15 times future earnings for 2025.
- Lower interest rates.
- Presidential election cycle dynamics.
Could we be wrong and the gains be straight up and not mostly in the second half? Sure. But we're recognizing the possibility the first half of 2024 could be challenged by competing market factions around the true trajectory of inflation. Still, we think significant macro factors support market breadth, especially when compared to the recent past:
Our readers may recall that investors pulled $240 billion from equities from October 2022 through the end of 2023 all while the S&P 500 gained 25.0%:
How did that happen?
Many companies, especially in the technology sector, bought back shares of their stock (likely because they were undervalued). Secondarily, hedge fund exposure went from extremely short equities in October 2022 to longish by the end of 2023 (i.e., short sellers were squeezed). These factors helped stocks gain, even as money exited the market.
Besides the fact that reaching all-time highs itself is a milestone, all-time highs also shatter the bear thesis. No bear market in history has produced all-time highs for stocks.
Look Through Headwinds
The ability to look forward is mission critical for investors. There may be consolidation in the weeks ahead, so the concept of “looking through” these headwinds is essential. This belief guides our data-driven approach partly because it provides us with short-term warnings.
We’ve recently highlighted historical evidence showing seasonal market weakness early in election years. Understanding that and current market dynamics, the short-term picture is beginning to emerge.
The latest data shows a slight change in tide, although no significant selling so far. Let’s turn to the trusty Big Money Index (BMI) from our friends at MAPsignals. The BMI is a 25-day moving average of “big money” professional investor activity. It’s fallen recently from a peak of 91.2% to 85.0% as of this writing, though remains overbought:
Keep in mind that markets are cyclical. They rise AND fall. So, it’s not a matter of if the BMI falls, but when. Sometimes it’s swift, like what occurred in February and August of last year (see chart above). But sometimes the BMI takes a while to fall from overbought territory, as it did during the pandemic.
There’s not much doubt about what happens when the BMI falls from overbought though – stocks fall. That’s why our short-term outlook is that equities could struggle in the first quarter. Instead of being discouraged though, investors should “look through” to envision what’s ahead.
To do this, we asked a simple question with help from our friends at MAPsignals: what sort of performance occurs when the BMI falls from overbought territory? Since 2009, there have been 29 such instances, with lackluster short term S&P 500 returns afterwards:
Even two months later, stocks are still negative, historically. Only after two months do the chances of stock returns being positive surpass a 50/50 probability (see Winning % above). We highlighted these wavy “dips after highs” in our previous post.
This expected short-term bumpiness stands in contrast to normal market behavior. What does that mean? Looking back at all one-week, two-week, one-month, and two-month averages since 2009, markets have an upward positive trend. Comparing that to periods when the BMI falls brings the pullback narrative into focus:
This means the real pain after the BMI falls from overbought territory tends to occur swiftly, during the first week after breaking out of overbought. Go back and review the BMI chart, the first two instances of the BMI falling from overbought were quick and steep.
To be clear: as of this writing, the BMI has not fallen from overbought territory. But we’re talking about it now so that when it happens, we know what to expect. And if we know what to expect, we can avoid emotional overreactions. Unemotional data allows for the “looking ahead” that’s so critical for investors.
Today, some buying is still happening at a healthy, constructive, clip. But we know the BMI will eventually fall. Averages tell us the BMI should fall 22 days after going overbought. In this case, that would work out to Jan. 19 (oddly enough when we hit an all-time high).
Though that's clearly not happening now, we know the BMI will fall at some point. Regardless of when it falls, staying the course and reacting as new data comes in is always the best path to avoid emotional mistakes. For now, let’s enjoy the smooth seas while they're here and recognize likely buying opportunities ahead.
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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.
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