Mid-week market update: We are entering the time of year when investors and traders position themselves for the end of the year. These conditions have made it more challenging for anyone trying to trade based on conventional technical analysis.
The most obvious is tax loss selling, when investors harvest losses to offset their (likely) considerable gains of 2024. Another is hedge funds shutting down their books in order to avoid the thin and potentially volatile market environment during the last two weeks of December.
We likely saw some hedge fund profit taking this week when Bespoke observed that winners were being sold and losers were being bought. This is consistent with market-neutral or long-short funds squaring their books for the year.
The anti-momentum, or price reversion, trade continued this week. The relative performance of price momentum ETFs all reversed sharply downward across the board.
Market cross-currents
End-of-year market positioning has also disrupted breadth indicators. Jason Goepfert pointed out that even there have been more declining than advancing stocks for seven consecutive days even as the S&P 500 is only 3% off its all-time high. This has only happened twice in the last 25 years. Even though such episodes seemed to have occurred shortly before major market tops, I am not sure that such readings lead conclusively to a bearish view in light of the low sample size and the unusual seasonal effects in December.
As I expected, the S&P 500 began to consolidate sideways and stage a shallow pullback after it ended its upper Bollinger Band ride (see Bitcoin 100K: Buy or Fade the Animal Spirits). What’s unusual about the current condition is even as the S&P 500 remains elevated, breadth internals are weak and oversold. The percentage of stocks above their 20 dma reached levels consistent with short-term bottoms when the market was in an uptrend.
A benign CPI report
Does that mean the short-term decline is over and stocks will start to rally into year-end from current levels? Equity bulls received a boost from the benign CPI report this morning, but selling pressure may not end until hedge funds wind up their profit taking. In addition, there may be further downside pressure from tax loss selling, though it will likely be reduced because there are fewer losses to harvest.
CPI and core CPI came in right at market expectations and inflation did not rise more than expected. This sets up a quarter-point rate cut at the December FOMC meeting. However, Powell may have to adjust market expectations about the pace of rate cuts in 2025 during the post-meeting press conference.
In conclusion, stocks are likely to begin a rally into year-end soon. Current conditions are difficult to navigate in light of severe seasonal cross-currents. I’ll be watching to see how price momentum behaves for signs that hedge fund profit taking is over. Be prepared for more near-term choppiness.
The 60:40 guardrail folks must sell stocks and buy bonds and that can be happening.
My biggest concern is for a big dip in the first two weeks of 2024 when folks with big gains that are waiting for the new tax year, sell.
The biggest drops in momentum ETF were those that do price momentum only since they own the stocks up 4 to 10 fold that got hammered. The momentum ETFs that do price PLUS a fundamental momentum screen did much better and are coming back strong (FDMO). They don’t own the meme stocks.
obvious meant first two weeks of 2025.
The 60:40 guardrail folks rebalance mechanically every quarter end.