@theMarket: Is January's Action Preview of the Year Ahead for Stocks?

The stock market has been a chop fest over the last two weeks. Yet, that has not stopped the technology sector from making new highs and the S&P 500 Index is not far behind. Are there more gains ahead for the averages before the end of the month?

 

Yes, as I wrote last week, I think there is at least one more good bounce in the markets before all is said and done. After that, I suspect we will all have to pay the piper for a while.

 

Has anything changed in investors' thinking to warrant these erratic moves? Much of the volatility over the last two weeks can be explained by the rise in bond yields and the strength in the dollar. Both instruments have made an abrupt turnaround from their downward trends that supported equities since October 2023.

 

I can identify two major concerns weighing on markets. The direction of inflation, and whether the U.S. economy is heading for a hard or soft landing. Neither of these outcomes will be known for several months. Until investors have a definitive answer, I believe markets will make little progress from here.

 

From all I have read and heard, not even the Fed knows if they have inflation licked. Sure, we have made progress towards a 2 percent inflation goal, but are still 2 percent above that rate. I can commiserate with the Fed’s position every time I go food shopping.

 

As for the economy, we are still seeing strength, and while economists continue to predict a softening of growth, it has not shown up in the data. The bears believe growth will fall off a cliff in one of these quarters and unemployment will spike at the same time. The Bulls say it won't happen. They believe that the economy and employment will maintain its present course upward and, at worst, we may have a soft landing if they are wrong.

 

Few are talking about a middle course, stagflation. That is where inflation remains sticky or strengthens a bit, while the economy slows at the same time. That could happen, if inflation remains stuck, and the Fed simply maintains tight monetary policy as a result. The longer they do that, the harder the landing for the economy will be.

 

But wait, you may ask, what happened to the bond market's conviction that the Fed will begin cutting rates in March and then five more times before the end of the year? The last two weeks have seen the chance for a March cut dropping from 90 percent to about even now. The number of expected cuts is also dwindling.

 

What if the economy does begin to slow? In an election year, any guess on what the Biden Administration might do? In an extremely tight race where the economy is a central issue, a healthy dose of increased fiscal spending would be no surprise. That has happened many times in the past.

 

 In case you don't know, most of the growth in the economy over the last few months has been the result of government spending and not the private sector. There are still billions of dollars that are part of the Inflation Reduction Act that have yet to be spent. Believe me, that is no accident. It is one of the main reasons why the Republican House, in my opinion, has been so adamant about cutting fiscal spending now.

 

So where does all of this leave the stock markets? In the short-term, as I predicted we are in bounce mode until the end of the year. That would require both yields and the dollar to behave. If I were a short-term trader I would sell into that bounce. Profit-taking after the gains of the last three months would be a no-brainer.

 

I maintain my belief that sometime in the weeks ahead, probably February at this point, stocks will face a stiff pullback of 6-7 percent, possibly more. This consolidation period will linger through April and into May.  At that point, I could see a spring-into-summer rally that would recoup those losses if the Fed does cut interest rates, the election draws closer, and we have a better understanding of where the economy and employment are going.  

 

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