The S&P 500 added a modest 0.2% Friday after challenging the highest levels in months earlier in the session.
I’m not sure where all of the bears have gone, but everyone crowing about a larger breakdown back in December has suspiciously gone MIA. But January’s strength shouldn’t surprise anyone. As I wrote back in December before the Christmas break:
The S&P 500 crashed more than 100 points Thursday morning [December 22nd] after someone yelled “Fire” and impulsive traders climbed over each other trying to get out.
What was the catalyst for Thursday’s selling? Easy, there wasn’t one. This panic was nothing more than impulsive traders getting spooked by their own shadows and then the herd following them out the door.
But this isn’t a surprise. This was the second to last trading session before the Christmas holiday and institutional investors are already at their vacation chalets. Without big money’s guiding hand, there was no one to keep impulsive retail traders in check, and like irresponsible teenagers given too much responsibility, these retail traders made poor decisions.
Lucky for us, these retail traders have small accounts and quickly ran out of things to sell. By early afternoon, supply dried up and the index rebounded 60 points from those oversold levels, easily reclaiming 3,800 support.
As Forest Gump famously said, “Stupid is as stupid does.” And on Thursday, retail traders proved why they have such a poor reputation.
Well, here we are a little more than a month later and the market is up 300 points and challenging recent highs. Not bad for the baby that was almost thrown out with December’s bathwater.
Of course, now we find ourselves on the other side of the pendulum. In December, we were challenging multi-month lows. Now we find ourselves challenging multi-month highs.
Did anything material change over the last several weeks other than the market’s price levels? No, not really. Inflation is moderating, just like it was in December. The economy is cooling, but only slightly and is still growing at a good clip, just like in December. And the Fed is poised to raise interest rates next week, but at a slower clip than previous raises, also like December.
So by a lot of measures, January’s rallied on “less bad than feared.” Unfortunately, this new-found half-full interpretation of headlines means we have a lot less room left to rally if headlines remain the same. At some point, “less bad than feared” is not enough and we actually need “better than expected” to keep pushing to fresh highs.
Will next week bring us the “better than expected” outlook from the Fed that we need to keep rallying? Or will the Fed rain on this parade like they have every other time the market got a little too far ahead of itself during this tightening cycle?
Markets move in waves and after a nice bit of up, it is time to get ready for the next bit of down. It’s been a nice run since the December lows and that means we are sitting on a pile of profits. But rather than get greedy, this is when we need to shift to a defensive mindset. There are few things more humbling than watching a leak in our bucket rob us of all of these hard-earned profits.
Remember, we only make money when we sell our winners. As easy as it is to buy back in, there is no reason to stubbornly hold on to a winning position as it moves away from us.
Now, to be clear, I am in no way calling this a top. But the risk/reward has shifted against us after 300 points of upside has been realized and the air underneath our feet gets higher by the day. Markets move in waves, that’s what they do. And we shouldn’t be surprised when the next routine and healthy wave lower arrives.
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Jani Ziedins (pronounced Ya-nee) is a full-time investor and financial analyst that has successfully traded stocks and options for nearly three decades. He has an undergraduate engineering degree from the Colorado School of Mines and two graduate business degrees from the University of Colorado Denver. His prior professional experience includes engineering at Fortune 500 companies, small business consulting, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two children.