Stock market seasonals flashing caution
Zero for two out of the gate.
The S&P 500 enjoyed a powerful 16.8% rally over a 9-week period into year-end 2023, its longest winning streak since 2004. That surge came close to achieving our year-end target of 4,800 (an intra-day high of 4,793 on December 28).
But the start to the New Year has been difficult, with negative readings on both the Santa Claus Rally indicator (down 0.88%) and the Early January Barometer indicator (down 0.13%). This supports our forecast of a potentially choppy and volatile 2024, but one that ends 8-9% higher at 5,200, compared with 2023’s very strong 24.2% price-only gain for the full year.
'If Santa Claus should fail to call, bears may come to Broad & Wall' The Stock Trader’s Almanac defines the Santa Claus rally as the last five trading days in December and the first two trading days in January. Over the past 54 years since 1969, the S&P 500 has been positive over this 7-day period 42 times (78% of the time) by an average of 1.3%. This year’s results were much worse, with a nominal decline of -0.88%, the tenth worst on record. But in the 12 years in which the Santa Claus indicator started the year negative, it finished the year in positive territory 67% of the time (8 of 12 observations).
Negative results for 'Early January Barometer' Historically, as the first five trading days of January go, so goes the full year. Since 1950, Jeffrey and Yale Hirsch at the Stock Trader’s Almanac report that 70% of the time (52 out of 74 observations), the direction of the full year—up or down—is the same as that of the first five trading days of January. But when the first five trading days of the new year are negative—as they are this year—the stock market manages to finish the year in positive territory 54% of the time (14 out of 26 instances).
Fundamentals driving the bus The fourth quarter S&P 500 reporting season starts today. At the beginning of October, the FactSet consensus was expecting profits to grow about 8% on a year-over-year (y/y) basis. But today, those estimates have shrunk to a modest y/y increase of only 1.3%. If achieved, that would mark the second consecutive quarter of growing profitability, after three consecutive quarterly declines. Revenues, in contrast, are expected to increase by 3.1% y/y, compared with a 3.9% y/y increase at the beginning of October. So profit margins continue to narrow, largely due to higher labor costs and interest rates.
What’s up with that? But the sharp decline in earnings expectations for the fourth quarter raises several important questions. Has the economy decelerated rapidly over the past three months? If so, that would be consistent with our fourth quarter GDP estimate of only 1.5%, compared with robust 4.9% GDP growth in the third quarter. Perhaps the cumulative weight of the Federal Reserve’s monetary policy tightening cycle is finally beginning to have the desired effect of slowing the economy to get inflation back to its 2% core PCE target.
Alternatively, company managements may have intentionally lowered their earnings bar over the past three months to engineer an upside surprise when they report their quarterly results in coming weeks. A third option is that company managements plan to kitchen-sink their fourth-quarter results, to push forward some revenue and profit growth into calendar 2024, which we expect to be a challenging year economically. GDP growth could limp along at only about a 1% run rate during the first three quarters of this year, as policymakers hope to stick a soft landing.
We still expect the Fed to begin to cut interest rates perhaps three times in the back half of 2024, in the wake of slowing economic growth. But the Fed has said repeatedly that it will be patient and vigilant regarding inflation. Just yesterday, for example, nominal CPI spiked to a hotter-than-expected 3.4% y/y increase in December, compared with 3.1% in November and consensus expectations for a modest gain of 3.2%. In our view, the market is overly optimistic that the Fed will cut interest rates six times this year, with the first coming in March.
Election curveball? To complicate matters, 2024 is also a presidential election year, and we’re expecting a contentious election with numerous curveballs. We may have one or more third-party candidates. That’s due to the dramatic shift in voter demographics recently: 46% are now registered as Independents, with 28% Republican and 24% Democrat.
In the 18 presidential elections since 1950, the year started and ended in the same direction as the Early January Barometer 83% of the time (15 out of 18 observations). But in the six presidential election years in which the S&P began in negative territory (like this year), the index righted the ship and finished positive 50% of the time (3 out of 6 observations). The S&P’s average performance during these 18 presidential election years was 7.3%, in line with our 8-9% forecast.
Reversion to the mean We’re keeping the defense on the field for now, expecting the S&P to revert from last year’s narrow 76% surge in the aggregate performance of the Magnificent Seven stocks due to AI FOMO. The rest of the index rose a more pedestrian 12% in 2023. So, we are focusing on those sectors that the market left for dead last year, as this rally potentially broadens out, including domestic large-cap value and small-cap growth, and international stocks, with an emphasis on international developed and emerging markets. These stocks generally have lower P/E ratios and betas and have much higher dividend yield support.
More to come We’ll return with January Barometer, Part II, in early February, after the S&P has generated investment returns for the entire month of January, to see what potential full-year market implications we can draw, and to identify what the top-performing industry sectors may be for the full year.