It has been a heck of a year for equities. Most investors should see double-digit gains when they open their January reports. Is the best yet to come?

 

Officially, the Santa Claus rally comprises the last five trading days in December, plus the first two trading days in January. If that tradition holds, we should see further gains from here. However, many worry that Santa came early and all we face into the new year is a downside.

 

They have reason to worry. We are already quite extended. Bullish sentiment is over the top. Bond yields have dropped so low in such a short period that many traders are looking for a rebound in yields. In addition, there seems to be an attempt by Fed officials to discourage investors from expecting the central bank to start cutting interest rates in March of next year.

 

Ever since the FOMC December meeting's pivot to a more dovish stance, yields have fallen dramatically, while stocks roared higher. The "higher for longer" message they have been spouting for months about interest rates, has been replaced by "too far, too fast" when assessing the gains in financial markets over the last few weeks.

 

In the latter half of this week, we did see some profit-taking, which was to be expected. After all, by Tuesday's finish, the Dow had registered its fifth record close in a row. Most indexes were up nine or ten consecutive days in a row. The record rally had pushed the S&P 500 Index within reach of its all-time high made in January 2022.

 

It is getting to the point that investors were expecting only up days and so were somewhat shocked by Wednesday's late-day sell-off. In the last hour and a half of trade, the markets took a sudden turn lower for no apparent reason.

 

The averages were all suddenly in free-fall with no news or event that could explain the decline. The Dow dropped more than 475 points, while the S&P 500 and NASDAQ declined more than 1.5 percent each. The small-cap Russel 2,000 lost the most at 1.89 percent. What happened?

 

Those readers who read my column last week — "Zero-Date Options Boost Market Risks" — have a leg up on how and why this sudden downdraft occurred. If you haven't read it, I urge you to do so.

 

ODTE is an acronym for zero-days-to-expiration options. An enormous amount of volume in the options market (over 60 percent) is in these one-day option bets on the direction of the market indexes. The ODTE market, in my opinion, has been transformed from a viable hedging strategy for professionals to something more akin to gambling on a horse race or buying a lottery ticket for many retail traders. The risk is enormous and given the right circumstances could impact financial markets drastically.

 

This week, we saw the risk involved when just a few bearish ODTE contracts triggered a mad rush for the exits. An army of option day traders (40 percent of ODTE traders are retail speculators), fearing a possible market sell-off, moved to one side of the boat at the same time. That created a cascading selling event that only stopped when the day was done, OTDE options expired, and the market closed. Overnight, without the pressure of bearish ODTE contracts, futures rebounded. By Thursday's opening, those same ODTE traders scrambled into bullish options bets once again.

 

As we head into the week between Christmas and New Year, most market participants will be taking off to celebrate the holidays. As a result, trading will be light and volumes quite low, which can set the stage for unexpected, and at times, wild gyrations in the markets. The OTDE options market can exacerbate that behavior.

 

There is a part of me that hopes we do see some further pullback in the days ahead. It would relieve some of the overbought conditions in the market. That would set us up next week for a further leg higher in markets, and possibly new highs into January. 

 

I urge investors to enjoy the gains because I fear this party will be coming to an end somewhere around the middle of January. At that point, expect to batten down the hatches, but more on that forecast next week. In the meantime, happy holidays to all and to all a good week.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

The chairman of the Federal Reserve Bank signaled this week that the Fed's monetary tightening policy may be coming to an end. Investors reacted by lifting the main averages higher, building on a more than 10 percent rally since October.

 

The "Powell-ful Rally," is how some pundits explained the spike higher in the averages after Wednesday's FOMC meeting. The S&P 500 Index, already in an overbought condition, rallied 1.5 percent. Thursday and Friday, traders consolidated those gains by taking some minor profits.

 

While most of the Fed's policy statements remained the same, investors did see and hear enough to believe that the Fed is unlikely to hike interest rates further. The Federal Open Market Committee members did indicate they are expecting the inflation rate will continue to cool. At the same time, they did not expect a sharp rise in unemployment, although unemployment could rise in 2024 to more than 4 percent.

 

Even more important to investors, after reading the Fed's forecasts for next year (called the dot plot), the likelihood of at least three rate cuts next year is now on the table. Their forecast for the Personal Consumption Expenditures, (PCE), the Fed's main inflation gauge, is expected to drop from 3.2 percent this year to 2.4 percent in 2024. That is a big decline.

 

But what caught my attention was this statement by Powell during the Q&A session: "You ask about real rates…," he said, "And indeed, if you look at the projections, I think the expectation would be that the real rate is declining, as we move forward."

 

What is the real rate of interest? The definition is simple. The real rate of interest equals the Fed Funds interest rate minus the inflation rate (real rate=Fed funds rate-inflation). What happens if inflation gets softer, as the Fed projects, but the central bank doesn't cut interest rates, the real rate of interest would go up. The only way the real rate declines is if the Fed begins to cut interest rates fairly soon.

 

That was all the markets needed to launch higher. I would describe the rush into equities this week as panic buying. The knee-jerk fear of missing out on further gains has stretched the indices upward to the breaking point. However, it seems that the catch-up areas that I have recommended (precious metals, small caps, materials, industrials, and financials) are now taking center stage while the Magnificent Seven are lagging somewhat. I still think technology is a great place to be but the juice in this end-of-year rally is my catch-up trades.

 

The markets have gone almost straight up over the last two weeks, which has not given side-lined investors a chance to get in and buy the dips. However, we may see some downside in the coming week as we almost always get after a big run higher.

 

The question on many readers' minds is how far this rally can go. After all, The Twelve Days of Christmas are not even here, and yet we already have three rate cuts, two turtle doves, and… I will let readers fill in the rest.

 

I am sticking to my targets. As I wrote back in November, "I expect we will make new highs and continue to climb to as much as 3,800 or beyond on the S&P 500 Index. As such, I would use any pullbacks to add to positions both in technology as well as industrials, and the catch-up areas I highlighted."

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

In the coming week, there are three hurdles that investors need to confront. Inflation data, a bond auction, and an FOMC meeting.

 

Investors are now convinced that job growth is finally slowing, inflation is a thing of the past and that the Fed will begin cutting interest rates as early as the second quarter of 2024. As such, they expect next week's Consumer Price Index will show further declines in headline inflation. Despite the almost one percent decline in the U.S. Ten-year bond, the U.S. Treasury's 10- and 20-year bond auctions will go off without a hitch. And finally, since inflation is dead and jobs are falling in an election year, the Fed will have no choice but to cut interest rates before the presidential elections.

 

Now if that sounds a bit like a Goldilocks scenario, I wouldn't blame you. There have been hundreds of strategy reports that have said the same thing with colorful charts and graphs proving these points circulating Wall Street over the last month. Given that, and knowing how the stock market works, all these positive expectations have already been discounted by the stock market.

 

What this means to me, is that each of these events must deliver results that are much better than expectations to move markets higher. We get the CPI report on Dec. 12. On Dec. 13 during the FOMC meeting, we need to see Fed Chair Jerome Powell not only indicate no more rate hikes but hint at cutting rates. And finally, U.S. Treasury auctions must be snapped up as a real bargain.

 

If that does not happen, use the example of Friday's unemployment report for November as a tell. Non-farm payrolls were slightly stronger than investors expected. The unemployment rate ticked down to 3.7 percent from 3.9 percent in October. The U.S. economy added 199,000 jobs versus the 185,000 jobs expected. That was a mild miss, but the immediate reaction in the bond market was to see the prices of both the ten-year and thirty-year bonds drop by more than 1 percent, while the dollar strengthened by more than half a percent. In other words, both equities and bond yields are priced for perfection and there is little room for disappointments.

 

This week, the decline in bond yields, coupled with the weakness in the U.S. dollar, has provided a cushion for the equity markets. It has been encouraging that small-cap stocks have largely led the markets throughout the week, while the Mag Seven gang has taken a bit of a back seat.

 

I suspect that the small-cap universe will see even more gains in the weeks ahead as will other areas that have languished this past year. The biotech area has also outperformed this week, and that will also be a winner, especially next year.

 

Another asset that I like has now come back into range. Precious metals have pulled back. Gold, after hitting a record high, is consolidating. I am looking at roughly $2,000 an ounce. as a possible entry point for those who want to speculate. Silver is also consolidating. Crypto, on the other hand, is close to the year's high and may also need to take a pause and consolidate before moving higher. 

 

Energy is starting to look tempting. I think the sell-off may be overdone and we could see a bottom sometime this coming week. For the year ahead. I think technology (AI), industries, and financials should be at the top of your wish list of areas that look especially interesting to me.  As for the coming week, I am still expecting more consolidation before an upsurge in stocks to close out the year. Use any dips to add to positions.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

Some of the 9 percent plus gains in the benchmark S&P 500 Index since October should be pared back in the week ahead. That doesn't mean Santa will thumb his nose at investors for the rest of the month. I am still expecting a traditional end-of-year rally.

 

Thanksgiving has come and gone, but stocks have hung in there as November ends. And while technology has marked time this week, we have seen basic materials, precious metals, industrial and financials come back to life.

 

The declining U.S. dollar is largely responsible for those gains. I don't think this upward momentum is over either. I am thinking that the greenback is going to continue to fall and as it does assets that are negatively correlated with the dollar will continue to gain. 

 

Some investors may remember that back at the beginning of August when I expected markets to decline into the September-October period, I wrote a column called "The Catch-up Trade." I highlighted basic materials, commodities, mines and metals, agricultural equities precious metals, small caps, and China as potential adds to your portfolio. 

 

I wrote that "All the above areas have been left in the dust this year as everyone's focus was squarely on the Magnificent Seven and lately AI stocks. As a contrarian, I am attracted to unloved areas like this. That is not to say that the technology sectors of the market will not participate. They will, just not at the same rate as those in a catch-up trade, in my opinion."

 

Except for China (and even there I am still waiting for a snap back higher), all the above areas are rising. Gold and silver have had pretty good runs. I am expecting energy to begin to climb as well. Even crypto, another beneficiary of a falling diamond, is doing well. I expect these areas to continue to climb in the weeks ahead.

 

As I have said, the main locomotive for this trade has been and will continue to be the dollar's decline. As investors see inflation coming down, and an end to the Fed's monetary tightening regime of the last two years, the yield on the U.S. ten-year Treasury bond has fallen by more than 70 basis points in the last few weeks. In turn, that has made the dollar less attractive, so traders are looking elsewhere for more attractive currencies, such as the Yen or even the Euro.

 

On a near-term basis (next two weeks), I am expecting the equity markets to consolidate with a risk of whittling down some of the gains we have enjoyed over the last several weeks. The American Association of Individual Investors (AAII) over the past week has seen the spread between bulls and bears widen by almost 30 points. The percentage of bulls has reached a six-month high, while bears fell to below 20 percent. As readers know, I use the AAII data as a contrarian indicator, meaning the more bullish the date, the higher the risk of a pullback.

 

On a technical basis, it looks to me that we are hitting peak levels on the main indexes. Technology and financials are close to July 2023 highs. Over in the bond market, I expect the decline in yields has been overdone, and we should expect to see a push back up to relieve overbought conditions.

 

If we do pull back, I am expecting something like a "W" pattern of ups and downs, but this should be completed by mid-December. And then what? I expect we will make new highs and continue to climb to as much as 3,800 or beyond on the S&P 500 Index. As such, I would use any pullbacks to add to positions both in technology as well as industrials, and the catch-up areas I highlighted. 

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

This stock market rally lasted nine straight days. That was more than enough to trigger some profit-taking.

 

"Too far, too fast" is my interpretation of the nine-day continuous climb in the equity and bond markets. The rally that started early last week continued this week, although it was clear to me that it is showing some signs of faltering.

 

And as has happened throughout the year, the Magnificent Seven group of stocks was the focus of most of the buying but on less and less volume. Since they represent such a large part of the indexes, it was not hard to see that the indexes were supported by a handful of stocks. However, the remaining 493 stocks in the S&P 500 Index are rolling over, which they have done all year.

 

Bond yields, on the other hand, have stopped going down. Instead, the U.S. 10-year Treasury bond had been consolidating. That is until the bond auctions on Wednesday and Thursday. The 10-year bond auction was fair, but the 30-year sale on Thursday did not go well at all. It was the weakest auction in almost two years. There was little to no appetite for long-dated bonds after the large decline in yields last week. On Friday, yields, and with them the stock market, recovered a bit.

 

To be clear, I am not convinced that we have seen the peak in long-term interest rates. If I look out further than January, I know that next year the U.S. Treasury will need to auction even more bonds simply to finance the government's existing spending plans. Some bond analysts expect more than $2 trillion in fundraising will be on the docket. If so, that should push interest rates back up and yields higher than where they are now.

 

As for the Fed, right now the betting is that there will be no rate hike at the December FOMC meeting. Some now predicting a rate cut as early as June 2024. Those kinds of predictions usually crop up to justify why stocks can continue to climb higher. I don't put much faith in that, especially when not one Fed member has even discussed rate cuts in the coming year.

 

In a speech before members of the International Monetary Fund on Thursday, Federal Reserve Bank Chairman Jerome Powell said the Fed is 'not confident' it has done enough to bring inflation down. He warned that more work could be ahead in the battle against higher prices.

 

 This statement was only a week after the FOMC meeting in which Powell's words were interpreted by the market as indicating the Fed was through raising rates. The moral of that tale is one usually hears what one wants to hear.

 

We are once again getting close to the deadline for a government shutdown. The Nov. 17 deadline is fast approaching and there is still no plan to keep the lights on in Washington. House Republicans are all over the map in what they want. Unfortunately, the new Speaker has yet to table any plan that would satisfy all his members. 

 

What is worse, Senate Republicans are now also demanding stricter border policies as a condition for Ukraine aid. At this point, the best that can be hoped for is yet another continuing resolution that would stretch funding out for another month or two. If not, I would expect the financial markets to hit some turbulence.

 

Chair Powell's words, combined with the poor bond auction, all on the same day (Thursday, Nov. 9), had bulls rethinking the market direction in the days ahead. I am looking for a minor pullback in the averages here short-term. A decline of 30-50 points on the S&P 500 Index should about do it from here. Anything lower than say 4,300 would tell me that there is more trouble in paradise than I am expecting.   

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.