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How to Play the "January Effect" in 2022


Stocks opened higher this morning before flattening out several hours later. Following yesterday’s big gain, it’s not all that surprising to see this kind of response, especially when you consider that most major trading desks are now closed for the year.

Wall Street’s biggest automated traders – aka, “quants” – don’t trade from Christmas to New Year’s. This leads to reduced trading volumes during this time, which can encourage increased volatility. It also can hamstring breakout rallies because quants are all momentum-chasing.

They use advanced machine learning and computer science to code algorithm-based, automated trading systems. Hedge funds lean heavily on quants these days to outperform the general market.

But when quants are on vacation, prolonged bullish breakouts are far less likely. The S&P blew past resistance yesterday, reaching a new all-time high in the process.

During any other week, quants probably would have jumped on that breakout again this morning, sending equities even higher.

This week, though, the quants aren’t available to “goose” share prices like normal. That’s why stocks are stalling. But come January, that all could change. And fast.

“We’re going to have a very strong January,” said Navellier & Associates founder Louis Navellier this morning, referencing yesterday’s major gain.

“If we can rally on light volume, we’re going to get an explosion to the upside when the volume increases in January.”

Navellier’s prediction makes perfect sense. If stocks can avoid a year-end rout this week, the impending surge in trading volume should see share prices soar as the “January Effect” takes hold.

JPMorgan’s chief market strategist, Dubravko Lakos-Bujas, recommends buying riskier, higher beta stocks (ones that tend to move “faster”) in preparation for an equity boom.

“In particular, outside of the Big 10 stocks in the U.S., equity drawdowns and multiple derating have been severe,” he said.

“Some argue this price action is a harbinger of late-cycle dynamics or at least an intra-cycle 10-20% market correction. In our view, conditions for a large selloff are not in place right now given already low investor positioning, record buybacks, limited systematic amplifiers, and positive January seasonals.”

Lakos-Bujas also explained that investors are “back to paying record premium” for the market’s lower volatility names. This has made the market’s already narrow-breadth even narrower as investors dumped higher volatility stocks in favor of "safer" mega-cap shares.

To nimble-minded traders, however, this may present a huge opportunity for outsized gains over the next month. High beta stocks look like a bargain compared to their low beta counterparts, which Lakos-Bujas said can be attributed to the market taking “the hawkish central bank and bearish Omicron narratives too far.”

He continued, adding:

“Performance in the hedge fund space has been poor lately with many giving back multiple quarters of gains. This resulted in forced liquidations and deleveraging at a time of low liquidity, triggering extreme stock price action, especially across the High Beta stock complex.”

Traders willing to buy the high beta dip may reap big rewards if that “extreme price action” flips to the upside. There’s still plenty of uncertainty in the market, of course, but investors have a knack for adhering to seasonal tendencies. Does that mean a bullish January is waiting for us on the other side of the New Year?

Probably. And it might not matter how many new Omicron infections there are, either, once the quants get back in on the action next week.
 

Stop Wasting Your Time on New Year’s Stock Predictions​

By Mike Reilly January 4, 2022

Nobody, and I mean nobody, can tell you with any amount of certainty what is going to happen over the next 12 months.

Yet, with the change in the calendar from December to January of a new year, we see the same lame headlines predicting this year’s winners… “Stock Outlook for 2022” or “Predictions for ‘22.”

Seriously, just stop reading this stuff. I mean it – your time is valuable, use it wisely.

Spend more time thinking about what’s in front of us now… spend your time considering what is happening, over what might happen later.

Want my 2022 prediction?

Some stocks are going to go up, some stocks are going to go down and other stocks will churn sideways.

And I bet come December of ‘22 that’s exactly what you’ll see.

Ok, now that we’ve dismissed the value, or lack thereof, in spending any of your precious time reading the year’s next winner list, let’s find something more productive to do.

As many of you know, we use technical analysis as the basis for investment decisions.

Technical analysis is the study of price behavior. And what we know for sure is that prices trend.

That’s a fact – it’s why technical analysis works.

We want to find trending markets and invest in them.

Our approach analyzes markets in the short- to intermediate-term time frame… which means weeks to months – and no further out than that.

Markets are much too fluid to say in January what to expect 12 months down the road. It’s a waste of time.

How about we worry about the next quarter? And then the next quarter after that, and then the next after that.

And before you know it, you’ve analyzed an entire year in real-time.

That makes a lot more sense to me. Why pretend we have any idea of what will be happening a year from now?

Focus on what is in front of you now don’t worry about what might happen 6-12 months from now. Too much can change.

Since this is your first installment of ADAPT Weekly in 2022, let’s make it productive and look at some price charts that will help illustrate the current investment landscape and by doing so, help you get off to a good start this year.

Believe it or not, with all the doom and gloom headlines about the latest iteration of covid and the potential implications, not all is lost.

True, 2021 was not an easy year to navigate financial markets and there were plenty of headwinds.

But in spite of challenges and headlines to the contrary, we’re seeing lots of all-time highs at both the index and sector levels.

Here’s a monthly chart of the S&P 500 index hitting new all-time highs.



And here is a relative strength chart comparing stocks to bonds. I love these kinds of charts. This relationship exemplifies risk-on vs. risk-off.

Do you see how in spite of all the fears over the resurgence of COVID, stocks are still stronger than bonds on a relative basis?



Stocks are showing both relative outperformance and absolute performance, as the S&P 500 hits new all-time highs.

And check this out… look at growth via the S&P 500 vs. defensive asset classes, Gold, and U.S. Treasuries.



If stocks were really about to roll over, the relationship between these three assets would look very different.

This next chart looks at the Dow Jones Industrial Average and the Dow Transports both reaching new all-time monthly highs.



For all of you Dow Theorists out there, this is a jackpot, as the Transports are confirming the highs in the Industrials.

We’re seeing new all-time highs on the sector level as well.

Consumer Discretionaries are making new monthly closing highs and Technology is currently ranked as the strongest sector of the 11 broad sectors we track – also hitting new monthly closing highs.

Not only that, but Healthcare and Consumer Staples are also joining the party with new all-time monthly highs.

So does this mean the moon and stars are all aligned for investors? Not necessarily. Just look at Small-Caps in the same quagmire they’ve been stuck in since February 2021.



And the Value Line Geometric Index is looking a lot like small-caps, trading sideways for the past year.



I like to look at the VLG because it represents the median stock – the average joe stock. We’d like to see both Small-Caps and VLG breakout supporting the case for a strong equity market.

Now let’s talk about sentiment for just a minute. Sentiment data is most useful when it’s at extremes – either overly bullish or overly bearish.

Coming into 2020 and even 2021, there was a lot of optimism in the markets.

We’re just not seeing that same level of optimism now. People today aren’t feeling good about the economy.



Historically when sentiment was at these low levels, they turned out to be good buying opportunities for stocks.

We wrote about this last summer when we believed the amount of optimism and bullishness was becoming a headwind for stocks.

Today, we don’t have that problem at all. If history is any gauge, sentiment readings could act as a tailwind for stocks, as more investors become more bullish and begin the next buying cycle, driving stock prices higher.

Now, is any of this a guarantee? No, of course not.

However, if we’re going to summarize what we’re currently seeing out of stocks, we have indexes and sectors breaking out to new all-time highs. Defensive asset classes are weak relative to stocks, indicating a risk-on market environment, and sentiment data is telling us there are potential buyers out there waiting to put fresh money to work.

This is what we can see happening today… now does this tell us what to do in June?

No, but it does provide evidence of uptrends in stocks. And that will have to be enough for now.
 
Taking a look at the current status of the S&P500, it can be seen from the moving averages on the chart that the uptrend is still intact. The next week when everyone gets back to work will hopefully give clues as to what to expect next.

 
Why the December Jobs Report Was Bad for Bulls


Stocks traded flat today in response to a lukewarm jobs report. December payrolls were released this morning and investors learned that the US only added 199,000 new jobs last month, which fell well short of the 422,000 job estimate. And though payrolls disappointed, the unemployment rate fell to 3.9%, down from 4.2% while beating the 4.1% estimate with ease.

Hourly wages came in hotter than expected (+0.6% month-over-month vs. +0.4% estimated), bringing the year-over-year rise to 4.7%, roughly 0.5% above the 4.2% estimate.

So, despite a poor headline jobs number, December’s report was a good one for workers. It showed that wages continued rising, and labor remained tight.

But for market bulls, it’s probably not a positive sign. We mentioned earlier in the week that the market is back in “good news is bad news” territory due to an impending hawkish shift from the Fed. Bloomberg chief economist Carl Riccadonna echoed our sentiment in an article this morning, citing the Fed’s “full employment” target of 4.0% unemployment.

“As we are already beyond that level (3.9% reported), this will compel any lingering fence sitters on the FOMC to the view that the threshold for interest rate liftoff has been met – thereby titling policy makers’ inclination toward March vs. June liftoff.”

Neil Dutta, head of US economics at Renaissance Macro Research, saw this morning’s report the same way.

"This is a green light for March," Dutta wrote.

"The U3 unemployment rate plunged 0.3ppt [percentage points] to 3.9%, 0.4ppt below the Fed's Q4 2021 estimate and only 0.4ppt above the Fed's estimate for year end 2022. Average hourly earnings are coming in firm as the labor force participation rate remains flat."

March is also when the Fed’s taper of asset purchases is expected to end, and according to the December FOMC minutes (released yesterday), the Fed may start to reduce its balance sheet at that time as well. It’s unlikely that bulls would be tortured by both a rate hike and a balance sheet reduction simultaneously, though, as picking one or the other would lead to a spike in yields, achieving the intended effect. Choosing to do both would be downright malicious.

Dutta also noted something else of importance: the fact that the labor force participation rate remained unchanged last month.



​

Like it or not, the US may never reach a pre-pandemic labor force participation rate again. Yes, Americans have increasingly come off the “government dole” since Covid hit.

But many ended up staying home, refusing to return to work. This has contributed to regularly higher than expected wage growth month after month. There are simply fewer workers available. Now, the US boasts a labor participation rate comparable to that of the late 1970s.


​
Does this seem like a trend that’s heading in the right direction? Labor force participation peaked back in the early 2000s and has been declining ever since. It finally rebounded from 2016-2020 after President Trump took office and the US economy began to truly flourish, prompting an attempted Fed rate hike to cool things down in late 2018.

This, along with many other factors, has made gauging the true health of the labor market a very difficult task. It’s also made the Fed’s job just that much more complicated.

And so, given today’s report, the Fed likely has the evidence it needs to start really turning up the hawkishness. Full employment has been exceeded. By the Fed’s standards, the “going is good.”

The question now is:

When will the rate hikes “get going?”

March seems like a good time to start, right when the Fed’s taper ends and a potential bear market reversal begins.
 
Will Rates Keep Climbing?


Stocks tumbled this morning as the rough start to the year got even worse. The Dow, S&P, and Nasdaq Composite all fell, scorching lower for significant losses. Today’s dip was likely driven by rising yields, which spiked again after already jumping higher last week. The 10-year Treasury yield hit 1.8% this morning, exceeding the pandemic high of 1.765% in the process.

This caused a slump in Big Tech shares, the majority of which endured heavy selling. Facebook-parent company Meta (NASDAQ: FB) was down 4% alongside chipmaker Nvidia (NASDAQ: NVDA). Amazon (NASDAQ: AMZN) dropped, too, falling 3%.

But it wasn’t just the market’s top tech shares that sunk. Over 70% of the S&P’s 500 stocks were down as of noon.

“Stocks are getting pulverized as tech extends its slump, but investors are forgetting to rotate, and the cyclical/value community is getting hit too as a result,” said Vital Knowledge’s Adam Crisafulli in a note to clients.

“It’s hard to blame any incremental news, and instead the same themes and trends as the last few weeks continue to weigh heavily on sentiment, specifically the withdrawal of stimulus and the effect this will have on equity multiples.”

And though Crisafulli’s take on investors “forgetting to rotate” is a little tongue-in-cheek, it’s also accurate. Value stocks beat growth to end the year. Now, both types of companies are down big as sentiment crumbles.

"The surge in rates since early December has crushed the valuation of stocks with high growth and low margins, but a well-ordered progression of Russell 3000 stocks implies further repricing," wrote Goldman Sachs chief strategist David Kostin.

"We have previously shown the speed of rate moves matters for equity returns. Equities typically struggle when the 5-day or 1-month change in nominal or real rates is greater than 2 standard deviations. The magnitude of the recent yield qualifies as a 2+ standard deviation event in both cases."

If rates climb further and at their current pace, growth stocks (ie, tech) will continue to see the worst of the losses, especially now that investors are expecting a Fed balance sheet reduction in March – something traders learned in the December FOMC meeting minutes release last week.

“That hawkish surprise hit the broad markets on Wednesday but especially high-growth and high-[price-to-earnings] tech stocks, as the prospects of the Fed aggressively tightening are most negative for high-growth/high-PE names,” said Tom Essaye, founder of the Sevens Report.

The “hawkish surprise” of a Fed balance sheet reduction may get even more hawkish in the next few days. The December Consumer Price Index (CPI) comes out on Wednesday, one day before the December Producer Price Index (PPI) is released. Both the CPI and PPI will provide the Fed with key inflation data heading into the January FOMC meeting, scheduled for January 25th-26th.

If inflation looks hotter than expected again, Fed Chairman Jerome Powell may seek to crank up the hawkish pressure once more. Ahead of that meeting, though, Powell’s set to testify before a Senate panel in his nomination hearing tomorrow. And while Powell will undoubtedly be confirmed, his testimony could provide significant monetary policy insight just days before a pair of critical inflation data releases.
 
In the above post Bill Poulos said, 'The “hawkish surprise” of a Fed balance sheet reduction may get even more hawkish in the next few days', so where are we at the moment. The SPY is heading down with some conviction but the equally weighted SPX is holding up much better. The VIX is under 20 so at the moment the market participants are not too worried.



If the HYG breaks through the lower support then the SPY could be in trouble, it should be an interesting week.

 
Is It Time to “Buy the Dip?”


Another day, another rebound. Stocks traded moderately higher this morning after enduring a strange trading session yesterday, in which the market sunk at the open before closing flat. Whipsawing yields had share prices peaking and plunging on an intraday sentiment “seesaw” that ran many traders ragged in the process.

Now, though, rates are starting to fall once more. The 10-year Treasury yield retreated from 1.80% to 1.76%, providing some relief to tech stock bulls. The tech-heavy Nasdaq Composite climbed over 1% higher in response.

What also lifted stocks this morning was testimony from the market’s most important man, Fed Chairman Jerome Powell, before the Senate Banking Committee.

“The Federal Reserve works for all Americans. We know our decisions matter to every person, family, business, and community across the country,” Powell said in a statement made as part of his confirmation process.

“I am committed to making those decisions with objectivity, integrity, and impartiality, based on the best available evidence, and in the long-standing tradition of monetary policy independence.”

All good stuff, and precisely what the Senate panel wanted to hear. He also explained that the Fed remains concerned about inflation and will take the steps necessary to control rising prices.

“If we have to raise interest rates more over time, we will,” Powell said.

“We will use our tools to get inflation back.”

It’s nothing new, but it’s also not the dovish surprise bulls were perhaps hoping for. Still, the market seemed unaffected by Powell’s remarks. A rally now looks to be building instead of a deeper selloff, and according to JPMorgan’s Marko Kolanovic, big returns could await investors who buy back in sooner rather than later.

“The pullback in risk assets in reaction to the Fed minutes is arguably overdone,” Kolanovic wrote in a note to clients.

“Policy tightening is likely to be gradual and at a pace that risk assets should be able to handle, and is occurring in an environment of strong cyclical recovery.”

Leuthold Group chief strategist Jim Paulsen offered a similar take:

“Historically, the stock market has suffered some nasty ‘temper tantrums,’ and numerous rate hikes eventually led to recessionary bear markets,” he said.

“However, the current focus among investors may be misplaced. The stock market’s response may have less to do with the timing and number of rate hikes than it does with the ‘direction’ of real earnings.”

Real earnings also looked great in 2018 before Powell’s rate hikes caused stocks to scorch lower for several months. Is a repeat performance on its way?

It certainly could be. And that’s definitely worth worrying about, even if the next earnings season looks good. Don’t forget that we’re in “good news is bad news” territory, where positive economic data (including strong earnings) may only cause the Fed to dial up the hawkishness further.

Does that sound like the kind of thing that bulls should ignore? Not if they want to avoid a severe “haircut” when the taper ends in March and the rate hikes (or Fed balance sheet reductions) are expected to begin.
 
The “Dirty Little Secret” in Today’s Inflation Report


Stocks traded flat this morning as bulls attempted to push shares prices higher once more. Following the release of the December Producer Price Index (PPI), however, much of the market’s enthusiasm from yesterday waned. Investors learned that producer prices climbed 9.7% year-over-year (YoY), falling just shy of the consensus estimate (+9.8% YoY).

And while an inflation “miss” these days could certainly be interpreted as bullish, December’s PPI print was nothing worth celebrating. It still represented a new record high for the index, up from November’s 9.6% yearly gain in producer prices.

“Stocks shook off the sticker shock of the historically high inflation number, but that was also widely expected and incredibly a non-event today really,” explained LPL Financial’s Ryan Detrick.

When food and energy prices were removed, December’s core PPI jumped 8.3% YoY, well above the +8.0% YoY estimate. The margin between Headline PPI and CPI remained wide last month (2.7%), too, suggesting that profit pressure persisted for corporations.

Wall Street still expects strong revenues from America’s top companies in the coming weeks, though, as earnings season gets underway this Friday.

“What we are excited about is earnings season is right around the corner,” Detrick said.

“We expect another solid showing by corporate America, while it will also be a chance to stop focusing so much on the Fed and policy, but instead get under the hood and see how the economy is really doing.”

The most important thing to consider when looking at the December inflation data is that gasoline prices fell 6.1% last month, dragging down the headline prints significantly. That will not be the case with January’s numbers, as WTI crude oil just eclipsed $82.00 per barrel yesterday, rising over 30% from the December low.

This could boost the January inflation readings substantially, which may only make the Fed squirm as it gets one month closer to March – the month in which most analysts believe the first 2022 rate hike will occur.

But will yields spike higher in anticipation of a rate hike? They already did earlier this week after the December FOMC minutes were released, causing a major “tech wreck” in the process.

And while rates should ultimately rise through February, they probably won’t move too fast for bulls to comfortably handle.

“We expect the US 10-year yield to move from the current 1.73% to around 2% over the coming months, as investors digest the Fed’s more hawkish stance along with further elevated inflation readings,” read a note from UBS strategists.

“That said, we don’t expect a sharp rise in yields that will imperil the equity rally. Year-over-year inflation is still likely to peak in the first quarter and recede over the year.”

UBS’s take on yields is a rational one. How the bank’s analysts feel about inflation, on the other hand, might be a little too optimistic. This estimate was made with the assumption that the Fed will actually raise rates when the time comes.

What’s more probable, however, is that Fed Chairman Jerome Powell finds some way to weasel out of a rate hike. Slowed economic growth or another surge in Covid cases might be enough to keep his finger off the hawkish trigger. This would help equities, of course, but at a great cost to the consumer as inflation rises further.

So, until March hits, a slow increase in yields should occur while the market makes new highs. Any uptrend from here would likely be a volatile one, but bulls could still see strong returns in the wake of better-than-expected corporate earnings.

Even with the first of three (possibly four) rate hikes looming in a few months.
 
If THIS Happens, Stocks Could "Flash Crash" Again


In the west, it’s all about rate hikes. Wall Street expects that the Fed will raise rates roughly four times this year. JPMorgan CEO Jamie Dimon shook things up last week when he predicted that the Fed would actually raise the federal funds rate a total of seven times. This caused a temporary intraday spike in yields.

But in the far east, China’s cutting rates instead. Beijing unexpectedly reduced rates today for the first time since 2020. The move was made in an attempt to reboot the Chinese economy, which has recently slowed due to Covid shutdowns and a sluggish real estate market.

“The [People’s Bank of China] really has started the New Year in a different position to, let’s say, other global banks and we do expect to see further easing or supportive measures, both monetary wise as well as from a fiscal stance,” said Fidelity International investment director Catherine Yeung.

US equity futures climbed slightly higher on the news alongside European stocks. And though the bond/equity markets are closed for MLK day, Treasury futures are pointing to a jump in yields tomorrow. The 10-year Treasury yield is on track to open above 1.80%, matching its post-pandemic high set last week.

That may seem like a bearish impulse for stocks at first glance. However, equities have risen in tandem with yields in the past. It's just that they tend to fall when rates move too quickly.

What qualifies as “too quick?” Historically speaking, stocks struggle when rates move more than two standard deviations within one month or less. That might seem like a wide range to work with, but the longer rates remain unchanged, the less “wiggle room” they have.

The standard deviation shrinks more and more as rates remain flat. This is what occurred on Jan 5th when stocks rapidly plunged in response to a spike in yields that well exceeded the two standard deviation limit.

“That hawkish surprise hit the broad markets on Wednesday but especially high-growth and high-[price-to-earnings] tech stocks, as the prospects of the Fed aggressively tightening are most negative for high-growth/high-PE names,” said Sevens Report founder Tom Essaye last Monday, referencing the December FOMC meeting minutes release in which investors learned that the Fed may reduce its balance sheet in March. This jolted yields higher, sinking stocks.

But will yields spike again in the coming weeks? UBS strategists released a note last week covering this very topic.

“We expect the US 10-year yield to move from the current 1.73% to around 2% over the coming months, as investors digest the Fed’s more hawkish stance along with further elevated inflation readings,” the bank’s analysts explained.

“That said, we don’t expect a sharp rise in yields that will imperil the equity rally.”

And though today’s Treasury futures activity indicates that yields will rise tomorrow, China’s rate cut is unlikely to cause a major US Treasury yield surge. It would take another unforeseen, hawkish action by the Fed to prompt that kind of response.

So, despite the market’s recent weakness and inability to truly rally, traders may be looking at yet another dip buying opportunity, simply because the Fed’s out of surprises for January. That could change if Fed Chairman Jerome Powell comes out and announces a February rate hike at the next FOMC meeting.

But for now, bulls probably have the “green light” to swing shares higher once more. Provided, of course, that corporate earnings come in better than expected this week.
 
Will the White House "Cancel" 5G Tomorrow?


Stocks fell again today as yields spiked this morning, hitting new post-pandemic highs in the process. Goldman Sachs (NYSE: GS) also reported a major earnings “miss,” souring investors on bank stocks even further after JPMorgan (NYSE: JPM) disappointed shareholders on Friday. This set a bearish tone for the current earnings season that’s only intensified in the wake of Goldman’s underwhelming revenues and forward guidance.

“Recent economic data is further confirming the economy is indeed slowing due to omicron. Retail sales, consumer confidence, industrial production, and the Empire State manufacturing all told a similar story, our economy is slowing and worries are growing,” said LPL Financial's Ryan Detrick.

“This isn’t the end of the world though, as we expect any near-term slowdown of output to simply be pushed back to further quarters once the Omicron worries subside.”

And though bank stocks dragged the Dow lower, the Nasdaq Composite endured the worst losses on the day. Tech shares were hammered by surging rates as the 10-year Treasury yield notched a new post-pandemic high at 1.856% as did the 2-year Treasury yield at 1.03%.

“The bond market is continuing to price in a more aggressive policy tightening by Federal Reserve based on still-high inflation and the Fed’s more hawkish guidance,” explained Oxford Economics chief economist Kathy Bostjancic.

“A fairly aggressive Fed tightening path will lead to somewhat lower valuations as economy-wide growth should slow as the Fed tries to soften the pace of demand.”

Few tech stocks were spared in the selling. Tesla (NASDAQ: TSLA) and Amazon (NASDAQ: AMZN) both fell 2.5%. Facebook-parent Meta Platforms (NASDAQ: FB) dropped almost 4% through noon.

But the next group of “biggest losers” could be tied to either the airline or wireless industries. It all has to do with the upcoming 5G nationwide rollout and its impact on commercial planes, which could ground thousands of flights in the next few weeks.

The reason being that 5G signals operate on a similar wavelength as those used by altimeters, which measure the distance between airplanes and the terrain beneath them. 5G signals have the potential to interfere with altimeters because of this.

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The FAA recently cleared most commercial planes for ultra-low visibility landing (when altimeter use becomes even more important) near 5G towers. On Sunday, however, Airlines for America, a group of airline lobbyists that represent Delta, American, Southwest, UPS, FedEx, and others, released a statement saying that the group remains concerned about disruptions to existing flight schedules due to poor weather conditions provoking more ultra-low visibility landings than usual.

“Even with these new approvals, flights at some airports may still be affected. The FAA also continues to work with manufacturers to understand how radar altimeter data is used in other flight control systems. Passengers should check with their airlines if weather is forecast at a destination where 5G interference is possible,” Airlines for America said.

The group believes that over 1,100 flights and 100,000 passengers could be subject to delays or cancellations each day.

“Unless our major hubs are cleared to fly, the vast majority of the traveling and shipping public will essentially be grounded,” the airline lobbyists said.

“The ripple effects across both passenger and cargo operations, our workforce and the broader economy are simply incalculable […] To be blunt, the nation's commerce will grind to a halt.”

If the lobbyists are right, this could make the ongoing supply chain issues in the US far, far worse.

The White House said this morning that it would work with airlines, wireless providers, and federal agencies to settle the dispute.

“The administration is actively engaged with the FAA, FCC, wireless carriers, airlines, and aviation equipment manufacturers to reach a solution that maximizes 5G deployment while protecting air safety and minimizing disruptions to passenger travel, cargo operations, and our economic recovery,” a White House official said.

The 5G rollout is supposed to begin tomorrow, but if the White House delays it, 5G stocks could face some short-term pain. Verizon (NYSE: VZ) and AT&T (NYSE: T) likely have the most to lose should Biden delay the rollout.

On the other hand, if the White House allows the wireless companies to plow forward, airlines could see their share prices drop instead if flights are canceled. This outcome could also impact the broader market assuming Airlines for America is right and poor weather causes significant backups at America’s major airports.

For bulls, the best outcome likely involves a 5G rollout delay. The alternative would arguably be a bearish impulse for the majority of the market, and at a very inopportune time with the S&P trading near its recent lows.
 

It’s All Bullish for Energy and Financials​

By Mike ReillyJanuary 20, 2022


One of the most important themes these days is the rotation between growth and value stocks.

To be clear, we’re not seeing a rotation out of stocks into risk-off alternatives, we’re seeing a rotation within the equity market.

Groups like Energy and Financials have been breaking to new highs while growth and Tech indexes have come under serious pressure (as you’ll see in our Relative Strength Analysis below).

We’re only 20 days into the new year, but so far 2022 is telling the story of two markets – and possibly foreshadowing what’s to come.

You see, while cyclicals and value stocks look to become this year’s outperformers, it looks like the party is finally coming to an end for the growth trade.

Here is a one-month chart of the 11 broad sectors of the U.S. market.



Take a look at the performance leaders: Energy, Staples, Financials, Industrials, and Basic Materials. In other words, value stocks.

Just as importantly, is what isn’t working… previous leaders like Technology, Consumer Discretionary, Communications – the growth stocks.

Further proof can be seen in our Relative Strength analysis of the broad sectors, as Financials and Energy hold the two top spots after displacing Technology (now #3). Industrials are close to breaking into the top four.

That would make three of the four strongest sectors cyclical value groups.

Energy stocks (XLE) have been on a torrid run. Beginning 2022 ranked #6 out of the 11 broad sectors we track, January 11 they were #4 and as of last night’s market close, Energy moved into the #2 ranked sector.

It’s also noteworthy that this is the first time in five years (2017) that Financials have been the top dog.

So, investors will want to lean into these value-heavy leadership groups in 2022. As for growth, well, as long as rates continue to rise, it’s likely to remain messy.

When we look beneath the surface at growth and value stocks right now, our breadth data is confirming what we’re seeing at the sector level.

Here’s one way to visualize how large-cap value and large-cap growth are moving in opposing directions.

This indicator shows us the percentage of stocks above their 50-day moving averages for each of these indexes:


Breadth or participation from large-cap value stocks has risen dramatically since December. The metric went from 20% to 70% in just over a month.

Large-cap growth looks very different. We’ve seen the number of stocks above their 50-day moving average fall from about 70 to under 40 in recent months.

I think Investors have two options – complain that growth stocks can’t seem to find a floor or rotate into the groups that are working. Don’t overcomplicate it.

For now, our breadth analysis is confirming the price action at the sector level. While nothing looks good in the growth space, it’s all bullish for energy and financials.

One thing we’re keeping a close eye on is for participation to broaden out to the other value sectors like Materials and Industrials.

It’s not quite there yet, and we want to see these areas participate and help confirm the value trend.

Here’s a look at the percentage of stocks above their 50-day moving averages for each of the value sectors.


Energy has an impressive 95% of stocks above their 50-day moving average, closely followed by Financials at 77%.

Before we can bet on a sustained rotation into value stocks, we want to see participation broaden to these sectors as well. Financials and Energy can’t prop up the entire market.

For now, we like the idea of leaning on leadership (Financials and Energy).

When it comes to the health of the overall market, we want to see an improvement in market internals from Industrials and Materials.

These groups following Energy and Financials to new highs would be a very bullish development. We’ll be keeping a close eye on them for confirmation.
 
The "Other Index" Most Traders Ignore (But Shouldn't)


Stocks endured deep losses at the open this morning before recovering slightly through noon. Overall, the market still seems shocked by yesterday’s afternoon plunge. On Wednesday, equities provided an eerily similar performance when the major indexes all opened higher before closing much, much lower.

This new pattern has bulls feeling wary about “buying the dip” for the first time in over a year. In fact, the S&P temporarily broke below its 200-day moving average (SMA) – a long-term trend identifying indicator – earlier this morning. If the index closes below the 200-SMA, it will be the first time it has done so in 409 trading days. That would measure the longest “win streak” above the 200-SMA for the S&P in over 8 years.

The last time the index closed below the 200-SMA was when Covid hit in late February 2020. Before that, the Fed’s rate hikes drove the S&P beneath it in late 2018.

And for the Nasdaq Composite, things are even worse. The tech-heavy index already closed below the 200-SMA last Tuesday and is having its worst January in more than 30 years.

Traders remained focused on the three major indexes – the S&P, Dow, and Nasdaq Composite – over the last few weeks, searching for signs of an upcoming rally or correction. These indexes were largely “rangebound” during that time, meaning that they were unable to make a concerted move either up or down.

Now, though, the S&P and Nasdaq Composite have broken past their December lows. The Dow remains above key support, but if the current trend continues, it will only be a matter of time before industrial stocks take out their December lows as well.

And while all of this was going on, most investors missed what the market’s “other” major index was doing.



The Russell 2000 (as represented by the iShares Russell 200 ETF) is a small-cap index, but it is seen by many as a better indicator of the US economy’s health than the S&P. The reason being that roughly 40-50% of the S&P’s revenues come from foreign sources while only around 10% of the Russell 2000’s revenues are foreign by comparison. That means Russell 2000 stocks are highly dependent upon domestic revenues to prosper.

And when domestic revenues are down, the Russell 2000 suffers for it. The index has fallen roughly 17.5% from its recent peak, almost qualifying it for bear market status (which most would argue requires a 20% correction from the recent highs) vs. the S&P’s much smaller 7.5% correction from its all-time high.

Worse yet, the Russell 2000 was effectively flat through the majority of 2021 while the S&P notched new highs week after week.

Historically speaking, whenever the Russell 2000 enters a bear market, the major indexes tend to follow. And the Russell 2000 is dropping for a very good reason. Investors are starting to realize that a rate hike is actually on its way in March, and according to the most recent crop of inflation data (the December CPI and PPI), inflation looks anything but transitory.

Don’t tell fund managers that, though. In the Bank of America Global Fund Managers Survey (released Tuesday), investors learned that 56% of the world’s top fund managers still think that inflation is merely transitory. Only 36% believe that it’s permanent.

This disconnect from reality is the kind of thing that drove the market’s wild price action in January. Money managers these days don’t know how to handle a portfolio while the Fed is tightening. Most have simply never experienced it, and they aren’t positioned properly as a result. This caused the market to become more prone to major price swings.

That's bad news for long-term, buy and hold investors, who have been forced to "white knuckle" their portfolios through January.

But for active, short-term traders? It’s been a bit of a gift, especially over the last week for any bears that took shorts on some of the market’s smaller-cap names. These are the same types of stocks included in the ailing Russell 2000, or as I like to call it, the “pulse index,” which traders should really be using to examine the state of the US economy far more than the foreign revenue-driven S&P.
 

The Death of 60/40: Starting Valuations Matter… A Lot (Part I)​

By Tim Fortier January 21, 2022


Welcome to week three of my series, The Death of 60/40.

The 60/40 Strategy is ubiquitous in the investment industry, but will likely fail to deliver future returns that are substantial enough to match most investor needs.

Last week I demonstrated how the historical returns for this strategy have been very dependent on the economic regime in play at the time.

Today, we’ll take a deeper look into the equity component of the 60/40 Portfolio and will discuss the current expectations for equity returns.

With 60% of the strategy allocated to stocks, stock market returns have been the strategy’s “muscle,” responsible for much of the overall return.

For purpose of analysis, I have constructed a portfolio composed of 60% Large Cap U.S. Stocks and 40% 10-Year Treasuries. My analysis period is from 1972 to 2021.

This period covers the inflationary 70s, the boom cycle of the 80s and 90s, and the various boom and bust cycles of the past 20 years.
From the beginning of 1972 to the end of 2021, $10,000 invested in this strategy produced a cumulative amount of $1,060,977 with a compound annual average return of 9.78%. Adjusted for inflation, the cumulative amount is only $156,405 or 5.65% CAGR.

Of this total cumulative amount, stocks produced $835,794 while bonds provided $215,183. In other words, stocks have provided nearly 79% of the overall return.

Additionally, in studying risk attributes to the portfolio, we discover that the 60% stock allocation is attributed to nearly 88% of the risk within the portfolio.

Because of the dominance of equities within this strategy, it’s vitally important to have a realistic expectancy for the future returns of stocks.

From last week’s discussions of historical returns, we know that the period 1982–2000 was the single best period only to be followed the single worst period of the “lost decade”.

My approach will be to examine stock market valuations at the beginning of each of those periods and then to compare them to the current market valuations.

NOTE: I am going to spend a little be of time providing some background information to help explain my main point. I will be breaking that into two segments to be continued next week.

Stock Market Valuations – Part 1​

There are many different means to measure a stock’s valuation. Individual stocks can be measured on a Price/Earnings, Price/Cash Flow, Price/Sales, Dividend Yield, or a Price/Book Value.

P/E ratios are a cornerstone of fundamental stock valuation analysis and are most commonly looked at for individual firms. The P/E ratio is a ratio of a stock price divided by the firm’s yearly earnings per share.

The same analysis can be done on the entire stock market. By adding up the price of every share in the S&P 500, and comparing that to the sum of all earnings-per-share generated by those companies, you can easily calculate the P/E ratio of the US stock market.

For instance, currently, the trailing 12 months of earnings for the S&P 500 is $178.24.

The current P/E is 25.56 (as of 1/19/2022)

If we take the current P/E x Earnings, we arrive at the current level of the S&P 500 Index ($178.24 X 25.56 = 4,555)

Historically, the P/E has averaged about 16, fluctuating between a low of 5.31 (December 1917) and a high of 123.71 (May 2009 – the P/E was so high because reported earnings declined significantly during the Great Financial Crisis).



There has been a clear relationship between earnings and price as both have steadily risen over time.



If we were to apply the “average” P/E ratio to the current earnings of the S&P 500, the index level would be 1,979 or about 44% lower!

I am not suggesting that S&P Index is heading to 1,979. I am only demonstrating that the multiple applied is extremely important.

It would be easy to predict the level of the S&P IF the multiple remained constant. Then, if we had a reasonable estimate for earnings, we could easily multiply to arrive at our price target.

If it was only that easy. Unfortunately, it’s not.

The multiple applied is determined by prevailing interest rates, investor sentiment, the macro environment, and of course, earnings to name a few of the important factors.

An important point to take away from this discussion is that a stock’s price can move higher just on multiple expansions alone. A stock with $1/per share in earnings at 15 multiple is priced at $15/share. Take the exact same company and give it a 30 multiple and the stock is now priced at $30, even though it hasn’t sold any more goods or services than the $15 dollar stock.

It’s just the multiple that is different (hang in there, I promise this is all coming together).

On January 1, 1982, at the beginning of the best period ever, the earnings for the S&P 500 were $45.56.

On December 31, 2000, earnings stood at $80.12 representing a 76% increase in earnings.

In the same period, the S&P increased from 133 to 1335.63 representing a 9X increase!

It wasn’t entirely earnings that drove prices higher.

When we examine more closely, the starting P/E on January 1, 1982, was 7.73.

One has to remember that interest rates at that time were 14.59% and investors’ confidence was quite low having had the recent experience of the 1970s stagflation.

As interest rates steadily fell and investor confidence increased, so too did the multiple that investors were willing to pay for earnings.

By the end of 2000, the P/E ratio stood near 30, up almost 4X from where it began nearly two decades earlier.

While earnings had risen during this period, so too did the P/E multiple and this accounted for the majority of stock market gains!

Read that last sentence again.

On December 31, 2010, earnings for the S&P 500 had increased to $98.39 yet investors who had bought and held the index for the prior 10 years had nothing to show for it.

This was because the P/E had contracted to 20.70 as investors had just been battered with the dot.com crash and the financial crisis of 2008–2009. It would take two more years for the P/E to bottom out and begin to cycle higher.

The chart below smooths earnings and adds overlays showing the modern-era average (arithmetic mean) P/E value of 19.8 (baselined as 0%), as well as horizontal bands showing +/- standard deviation bands. As of January 14, 2022, the S&P 500 P/E ratio is 90% higher than its modern era average.



What we can glean from this information is that the single best era began with a historically low P/E ratio which allowed for both earnings growth and P/E expansion.

The “Lost Decade” began with a P/E ratio that was historically high – over two standard deviations above the historical average. This led to a period where the market went nowhere for nearly 12 years. Even though earnings did manage to grow some, it wasn’t enough to compensate for the contraction in the P/E multiple.

Which brings us to today, where we find ourselves facing a similar extreme high valuation reading.

I will conclude my outlook for stocks next week in Part 2 of “Starting Valuations Matter… A Lot,” where I will examine a variety of other valuation metrics that all bode similar warnings to investors.
 
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