January did its job by producing monthly gains that aligned with historical expectations for a pre-election year. Not only did all major indices post substantial gains during the month, but the market provided some positive indicators that continue to point to better days ahead. We already discussed two of these: the Breakaway Momentum Indicator we received in mid-January and the January Indicator Trifecta last week. These indicators lead to strong forward market performance. As we head into February, we can lean on additional data and indicators to help maintain faith in the market moving past last year’s bear market.
These data points and indicators include the following:
NYSE January Breadth- the average daily breadth for the NYSE, which is the difference between the number of daily advancing issues versus daily declining issues on the exchange, was the strongest we have seen in almost a decade.
The average number of daily advancers for the month was 1,930, well ahead of the 2022 average of 1,561. The last time the market posted a January that was this robust in breadth was in 2019, which was the kickoff to a double-digit return year for the market.
Bond Breadth - one of the major issues in 2022 was the lack of liquidity in the bond market due to the hyper-aggressive actions of the Fed.
Again, looking at breadth for both the Total Bond market and the High Yield Bond market, 2022 was a very negative year. The Total Bond market averaged -582 daily decliners, while the High Yield market averaged -91. So far, 2023 has reversed this trend as January produced positive breadth for both the Total Bond and High Yield markets. Total Bond posted 1,350 daily advancers, and High Yield added 241. Both monthly numbers are the strongest we have seen since the initial post-Covid market months, showing that liquidity has been coming back into the market in a big way.
Money Flow Records- it’s difficult to remember that our daily S&P 500 Money Flows bottomed out almost exactly one year ago. On January 20th last year, our positive money flow percentage bottomed out at 21.47%. Roughly 100 stocks out of the 500 in the S&P 500 Index were trading with positive money flows at the time. As with breadth, money flow will always lead price. Fast forward a year, and we are posting record money flow data as there were more than 90% of the S&P 500 stocks with positive money flows as of January 31st. In a year, we have seen positive money flows jump from roughly 100 S&P names to over 450 S&P names. Another extremely bullish data set for us to consider when determining market direction.
Overbought to Start
All the strength we have seen in January has put the market in an overbought position. With the Nasdaq and Russell 2000 posting two of their best January returns on record, the market may have to cool down before working on its next move. As the historical data from the past Breakaway Momentum Signal showed, there is an opportunity for the market to consolidate in the month and a half following the signal date (January 12th, 2023). As we head into February, we must keep an open mind about the potential consolidation of the January gains as the market works off its excess.
Managing Communication
While the last month of market gains have been excellent and welcomed, we must keep in mind that several issues still facing the economy and market could cause expectations to change moving forward. Once again, most of these issues surround the Fed and how they interpret future economic data. We continue to expect the Fed to slow down from their record rate hike cycle of last year, but as 2022 showed us, the Fed’s actions and comments do not always match very well.
For example, Fed Chair Jerome Powell suggested at the June 2022 post-FOMC press conference that “jumbo-sized” fed rate increases would not become the norm. The Fed then went on to hike 0.75 by the following three meetings.
Following the July 0.75 rate increase, Powell started his press conference by saying that the Fed had moved expeditiously to get to the range of neutral, “and I think we’ve done that now. We’re at 2.25% to 2.50%, and that’s right in the range of what we think is neutral.” A month later, at the annual Jackson Hole symposium, Powell painted a much different picture, calling for a more considerable rate increase to continue and expecting the Fed to have to remain higher for longer, well above the neutral rate they believe the economy was at a month ago.
The aggressive nature of the Fed has led everyone to believe that we are heading for a recession in 2023, or as we call it, "the most anticipated recession the economy has been talked into." Even after the rate increase from the Fed over the last 12 months, there is little data that looks recessionary to us. But this seems to be the driving force of Fed action; to kill inflation, you must significantly impair the overall economy. The main sticking point right now is unemployment, which remains stubbornly strong in the Fed’s eyes. I never thought that rising unemployment was good for the economy.
Moving forward into this year, we know there will be market periods where expectations are not in line with reality, causing volatility to increase. Our goal remains to help manage these expectations for our clients and provide the necessary advice to take advantage of these situations as they arise. Just remember that it does not matter what Jerome Powell says after an FOMC meeting. It does not matter what the monthly non-farm payroll data is. It does not matter what the monthly change is in the CPI data. What matters is how the market reacts to this data.
February Expectations
February has traditionally been the weak link in the 'best six months’ of a market year. But February significantly outperforms during pre-election years. Over the last 70 years, it is the second worst month of the S&P. This has held true of late as the S&P 500 in February 2018, 2020, and 2022 showed more than 3% declines. But pre-elections years are highly different for February as all significant indices average greater than 1% returns, with the Nasdaq and Russell 2000 leading the way with more than 2% gains.
As we continue to collect bullish signals, such as the January Trifecta we noted last week, our conviction will increase that 2023 will follow the traditional path of the pre-election market. The chart below shows the performance of the S&P 500 in pre-election years based on certain criteria:
The chart above shows that we should expect February to start on solid footing, continuing the strength seen in January before flattening out during the second half of the month. Given the market’s highly overbought nature, we expect February to be more of a flat transition month. But given the continued bullish tilt to the market and the historically strong market period between March and mid-May, we would use any weakness in price action to gain more exposure to the long side.