We will review 2022 and offer much more detail about the months ahead in our 2023 Outlook Video which will be released in the next week.
The Pre-Election Year
The Mid-Term Election Year is almost always the most difficult for the market; however, the Pre-Election year is almost always positive. There have only been two negative pre-election years in the last century, with the last occurring in 1939 when Hitler began his march on Poland to initiate World War II. The chart below shows that the average return of pre-election years has been a robust 18.47% over the last 24 occurrences.
While anything is possible, our base case is that this year will follow the historical trends of the pre-election year.
January Historical Indicators
There are a few market barometers that occurred during the end of December and in the beginning of January that have also historically been excellent indicators for the road ahead:
The Santa Claus Rally - “If Santa Claus should fail to call, bears may come to Broad and Wall.”
The Santa Claus Rally covers the performance of the S&P over the last five trading days of December and the first two trading days of January. On average, the Santa Claus Rally produces a return of 1.3%, but in years where the rally does not occur, it often precedes a bear market or at least a period where the market is weaker than expected. This year the S&P eked out a 9-point gain, satisfying the rallies requirements.
January’s First Five Days - This is a relatively simple indicator; if the S&P 500 is up over the first five days of the year, there is a greater than 80% chance that the rest of the year will produce a positive return. This indicator is almost perfect in indicating negative market years when the first five trading days of a year are down more than -1.0%.
For example, last year, the S&P was down -1.0% through the first five days, and we don’t have to explain how the rest of the year went. Through the first four days of 2023, the S&P 500 is up 1.45%.
January Monthly Barometer - “So goes January, so goes the year.” Every down January since 1950, without exception, has preceded a new or extended bear market, a 10% correction, or a market that ends flat on the year. The market typically will pull back another -13% from a negative January reading. In recent years, this pullback has presented an excellent buying opportunity.
On average negative January performance since 1950 leads to a negative -1.1% return for the S&P through the 11 remaining months of the year. We will update the January Barometer in our February outlook.
With a new year and a new market, we still have all the same problems. While the rolling of the calendar resets annual market performance, there is no doubt that the negative overhangs of 2022 remain in place. Thankfully, even if it’s only short term, the month of January in pre-election years usually offers a relief rally from the weakness of the mid-term market. January offers the best annual returns for the Dow, S&P 500, and Nasdaq for the pre-election market year. Both the Dow and S&P average returns around 4%, and the Nasdaq historically has posted roughly 6% returns, all well above average.
While history tells us that the January market should outperform, we have several of our technical indicators telling us the same. Our daily positive money flow indicator for the S&P 500 is at 73.02%, a well above average reading and well above the 30.39% positive money flow of the S&P a year ago. Looking at a larger picture using the S&P 1,500 Index, which includes the S&P 500, 400, & 600, we currently have 57.53% of this index listed as outperforming or positive on our system versus a reading of 22.28% a year ago. Even simple indicators like the New High versus New Low indicator show a positive divergence and less selling pressure overall. The market generally continues to check off the positive indicator boxes, and it is ripe to start transitioning positive technicals into positive price action.
For the first time in a while, there is a hint of bullishness around Wall Street.
Whether this is just Wall Street still being hungover from New Year’s Eve or an actual positive shift in sentiment remains to be seen. The Fed continues to remain the top concern of the market; what they say or do not say will continue to drive action over the short term.
We all know too well the trap doors that the Fed can open up in the market with their comments, which happened several times in 2022 and all started with the release of the December 2021 Fed Minutes on January 5th, 2022. While these trapdoors may continue to occur, it is crucial to pay attention to events where negative comments arise. Many rallies begin when the actual numbers come in better than expectations. And expectations are currently quite low.
We have already had one of the inverse reactions in 2023 with the release of the December Fed Minutes last week on January 5th. The December Fed minutes reinforced the Fed’s desire to stay higher for longer, which typically would have sold the market off and started a multiday pullback.
The initial weak response to these minutes was reversed rather quickly, and we have seen the market rise by more than 3%. This is a very positive indicator for the overall market moving forward. With a slight shift in general sentiment and a number of our indicators turning bullish or remaining bullish, we assume that January will follow the historical patterns of the pre-election year and offer a welcomed relief rally for the market.