As seasonality shifts, is the next large move up or down?
With risk assets running out of ‘narrative’ gas on Jan. 17, the bulls need new fundamental catalysts to maintain the upward momentum. However, with investors’ confidence showing signs of slippage, sharp reversals should unfold sooner rather than later.
For example, bullish seasonality helped underwrite the S&P 500’s uprising in recent months. But, with the seasonality clock now bearish, the crowd will have a tough time ignoring the deteriorating fundamental backdrop.
Please see below:
To explain, the red circle on the left side of the chart above shows that S&P 500 seasonality often turns in mid-January, and the negativity persists until the end of the month. As a result, the pressure should mount in the days ahead.
Even more revealing, the stock market’s recent optimism has been driven by short-covering, not economic enthusiasm. As evidence, Goldman Sachs’ basket of the most-shorted stocks has materially outperformed in January.
Please see below:
Source: Bloomberg/ZeroHedge
To explain, the index has jumped by 20% since the post-non-farm payrolls dip, and the squeeze highlights why the strength is unlikely to last. In other words, when a ‘dash for trash’ drives the S&P 500 higher, it sets the stage for another sell-off.
As further evidence, the basket had its best weekly performance since April 2020.
Please see below:
To explain, the blue bar on the right side of the chart above shows how the index soared by 15.7% last week; and with great dispersions often preceding great reversions, a sharp reversal of fortunes should weigh heavily on the S&P 500.
On top of that, CNN’s Fear & Greed Index is near levels that coincided with 2022 reversals.
Please see below:
Source: CNN
To explain, the index hit 65 on Jan. 17, and the April, August and November highs were 62. 68 and 70. As such, optimism is abound, and investors are often the most bullish near the top.
From the opposite angle, the Cboe Volatility Index (VIX) – which measures the S&P 500’s expected volatility over the next 30 days – is also at levels that signal an upcoming bout of negativity.
Please see below:
Source: CNN
To explain, the blue line above tracks the VIX, while the orange line above tracks its 50-day moving average. If you analyze the right side of the chart, you can see that the VIX (< 20) is near the troughs that preceded the sell-offs in April, August and November. Thus, when combined with CNN’s Fear & Greed Index, the setup has profoundly bearish undertones.
Now, while these measures have short-term implications, the S&P 500’s medium-term backdrop is also highly bearish; and due to the interconnectedness of the financial markets, the cascading effect often impacts gold. So, if the S&P 500 still has considerable fundamental downside, the PMs are unlikely to celebrate the sell-off.
Please see below:
To explain, Bank of America found that the S&P 500 has never recorded a lasting bottom until the ‘Rule of 20’ is satisfied. For context, it means that when the S&P 500’s trailing price-to-earnings (P/E) ratio plus the year-over-year (YoY) percentage change in the headline Consumer Price Index (CPI) exceeds 20, the bear market still has room to run.
Furthermore, if you analyze the right side of the chart, you can see that the blue line remains above the bottom threshold (the brown horizontal line), which means that one of two outcomes must occur to satisfy the rule: either the YoY CPI declines rapidly, or the S&P 500’s trailing P/E falls; and with the latter much more likely than the former in our view, the short and medium-term outlooks for the index are bearish.
Also noteworthy, we’ve highlighted the importance of the Atlanta Fed’s Sticky CPIs on numerous occasions. In a nutshell: they are better gauges because they measure broad-based inflation across items that change price infrequently; and with the headline and core Sticky CPIs hitting new highs for 17 straight months, their strength contrasts the energy-driven declines in the headline CPI, which the crowd has celebrated.
Yet, the core Sticky CPI's ascent is bullish for the U.S. federal funds rate (FFR).
Please see below:
To explain, the red line above subtracts FFR from the YoY percentage change in the core Sticky CPI. The important development is that before the Fed ends its rate hike cycles, the spread between the FFR and the YoY core Sticky CPI always turns positive.
If you analyze the peaks and valleys, you can see that anytime the spread turned negative since 1967 (YoY core Sticky CPI > FFR), it returned to positive territory. Even in 2019, the metric hit 0.03%. Therefore, with the core Sticky CPI hitting 6.61% YoY in December (a new cycle high), and the current spread of -2.5% nowhere near equilibrium, the FFR should have plenty of room to run.
For context, the spread was negative post-GFC, but inflation was a non-issue then, and the FFR could remain near zero. Conversely, the current environment is much different.
Finally, while seasonality, sentiment, and the medium-term fundamentals remain highly ominous for several risk assets, another interesting development is unique to gold.
Please see below:
To explain, the candlesticks above track the gold futures price, the black line above represents its 100-day moving average, and the blue bars at the bottom represent the percentage distance between the daily price and the 100-day MA.
If you analyze the left side of the chart, you can see that the Russia-Ukraine crisis pushed the gold futures price 11.91% above its 100-day MA on Mar. 8, 2022. But, the development marked peak optimism, and gold suffered mightily in the months ahead.
Likewise, the recent optimism pushed the gold futures price 10.42% above its 100-day MA on Jan. 13. So, while we’ve noted that investors are often the most bearish at the bottom and the most bullish at the top, the recent euphoria rivals the optimism from March, and a reconnection with the 100-day MA implies a pullback below $1,750.
Overall, while the fundamental backdrop has always been bearish, the sentiment setup also supports lower precious metals prices. Consequently, we view the risks as heavily skewed to the downside, especially for silver and mining stocks.
How are you playing the seasonality shift? Will earnings optimism outweigh the S&P 500’s mid-January sorrow? And how concerned should the gold bulls be about the current setup’s ominous similarity to March?
Alex Demolitor
Precious Metals Strategist