By Cory McPherson | December 2021
Year-End Review of the Market
While the stock market is entering a very strong calendar period historically, it has been a turbulent and highly volatile past week. December has historically been one of the best times to be in the market, as we get what many market commentators call a “Santa Claus Rally.” According to data from Bespoke Investment Group, the S&P has had a positive return in December 74% of the time since 1928, higher than any other month. While we don’t explicitly invest based on seasonality or calendar periods, we certainly keep these items in mind.
This December is setting up to be quite interesting, as multiple risks have risen over the last couple of weeks. The discovery of a new COVID variant last week caused a drop in the market during limited trading hours on Black Friday. The fear of countries reimposing lockdowns and other measures spread quickly.
While the COVID risk still lingers, we believe the market reaction this week has more to do with comments from Federal Reserve chairman, Jerome Powell. As we have explained in previous newsletters, so much of this market rally since March 2020 can be attributed to the extremely loose monetary policy from the Fed. It had been continuously buying $120 billion each month in treasury securities and mortgage-back securities. It has also kept its benchmark interest rate at zero. Beginning in November, the Fed began its “taper” strategy of reducing their asset purchases each month with the intention of ending asset purchases in June of 2022. Fed Chair Powell on Tuesday indicated the central bank could speed up the taper strategy due to inflationary pressures saying, “At this point, the economy is very strong and inflationary pressures are higher, and it is, therefore, appropriate in my view to consider wrapping up the taper of our asset purchases, which we actually announced at the November meeting, perhaps a few months sooner.” This came as a surprise to the market as stocks began to sell-off, and short-term interest rates began to rise.
Fed Chair Powell also made comments about inflation, indicating the central bank no longer considers it to be “transitory” as they have been saying for most of the year. This indicates the Fed may become more aggressive next year in trying to tame inflation by raising their benchmark interest rate sooner than expected. Many investment bank analysts have projected interest rate increases to start at the end of 2022/early 2023. But if the tapering of asset purchases gets sped up, it’s quite possible the interest rate hikes begin soon after. Thus, short-term Treasury rates have recently spiked, as traders anticipate the rate increases.
As the market attempts to digest the reality of tighter monetary conditions in the near future, volatility has spiked, and the market has pulled back to near important support lines. The chart below shows the recent pull back that has occurred, but also the healthy uptrend that remains going back to the beginning of the year.
We believe the market is at an important point, near its 50-day moving average (blue line), which has shown to be support for most of the year. Fortunately, in many of our portfolios we are holding more cash than normal. During October and early November, the market had a rapid rally almost going parabolic. History tells us when this happens it is usually followed by some type of a pullback in price, and that’s what we were expecting. We have now seen that, and it’s just a matter of how far it drops if it hasn’t bottomed yet. The charts tell us this could be a logical point where it begins to rally into year-end. But, with the known risks, this could set up to be an interesting December.
Market breadth has also deteriorated over the last month, which is a cause for concern. In the chart below we show the New York Stock Exchange (NYSE) advance-decline line. We highlighted this in our August newsletter, which measures market breadth by subtracting declining stock issues from advancing stock issues. When the line is going up it means more stocks are participating in the advance. It was a positive sign in October and early November as the advance-decline line rallied to new highs after consolidating for several months. We want to see this line make new highs when the market is making new highs, meaning the market has broad participation. It is now back to levels it was at during most of the summer months. This could also be a logical point to see it begin to bounce, and we will want to see that happen if the market also begins to rally.
Another sign of weakening breadth is the spike we’ve seen in new 52-week and 6-month lows for stocks in the NYSE. The number of stocks at their lows are at some of the highest points we’ve seen this year. While this is a reason to be cautious, the positive spin could be that these lower levels of market breadth have marked turning points over the last year. With the S&P index sitting near support and being held up by a small number of stocks, it is important to see these breadth metrics begin to improve. If not, the uptrend we’ve seen in stocks this year will be in danger.
We continue our position of being open to any and all possibilities for the market. We are prepared to lower risk in portfolios as our indicators start turning negative and prepared to deploy some of the cash holdings if we see the market rally into the year-end. We get asked frequently for predictions on what the stock market will do in 2022. As always, we do not make predictions on where the market will go, we leave that to the financial media. We’ve seen a great year in the stock market so far with one month to go. That might lead some to believe next year will be a down year, and some might believe the rally will continue next year. We plan for different scenarios and react to market conditions accordingly based on our indicators and signals, not based on predictions.
As we go into the year-end after enjoying time off for Thanksgiving with family, we at ProActive Capital Management wanted to give thanks to you, our clients. We’ve seen tremendous growth in our business since becoming ProActive Capital Management, and most of that can be attributed to you. Much of our new business comes from client referrals, and we appreciate our clients spreading the good word about our firm. As Christmas fast approaches, we hope everyone has a safe and enjoyable holiday, as we look forward to another great year of working with you.
Cory McPherson is a financial planner and advisor, and Senior Vice President for ProActive Capital Management, Inc. He is a graduate of Kansas State University with a Bachelor of Science in Business Finance. Cory received his Retirement Income Certified Professional (RICP®) designation from The American College of Financial Services in 2017.