Markets consolidating after January gains

They say you can't keep a good market down. That is proving to be the case thus far in 2023. Every dip continues to be bought and the technical charts indicate there may be more upside ahead.

I was expecting that January's bounce in the averages would reverse in February. So far, I have been wrong. I did provide some caveats. For example, I recognized that my forecast had become the consensus view, and that made me uncomfortable. I also wrote back at the end of January that if the Fed moved into a more dovish stance "my prediction fails to materialize, and the market continues to grind higher, we could ultimately see 4,370 on the S&P 500 Index, which is another 300 points higher from here, before all is said and done."

The S&P 500 this month climbed as high as 4,195. Presently, profit-taking is relieving some of the overbought conditions in the short term. However, profit-taking becomes something more serious if we break 4,070. So far, we have held that level. 

The practice of buying dips is also back in vogue. In case after case during this earnings season, companies that reported disappointing results have seen their stocks fall at first, only to be bid up within hours or days. Markets overall are doing the same thing. Short, sharp selloffs are almost immediately followed by gains. The technology index is leading, while the largest gains in stocks are from those companies with little to no fundamentals.

For those who like to follow the technical charts of the markets, most technicians would say the indexes remain bullish. Targets for the S&P 500 Index vary, but in the short-term 4,200-4,300+ seems to be entirely possible.  

In past columns, I have written that the options market is now the main mover of stocks. Investors can buy one option which gives the owner the right to buy or sell 100 shares of a stock for a limited period. Over the past several weeks, one-day options represent more than 60% of all options trades. In short, welcome to the casino.

Each day, speculators buy zero-day-to-expiration call (or put) options and profit from fast moves in a stock like Tesla. They then cash in by the end of trading on the same day. It has little to do with fundamental things like earnings and prospects for a company and it is certainly not an investment. How long can this practice continue—until something changes?  Remember also that the implied leverage in options works both ways. Stocks can move down just as rapidly as they have moved up.

One of the chief macroeconomic drivers for the equity markets has been the decline in the U.S. dollar this year. Higher interest rates normally mean a strengthening currency. If interest rate yields remain stable or decline in the U.S. (as they have been doing lately), while other countries continue to raise their interest rates, then the dollar weakens. That is what has been happening now for several weeks.

Global currency traders are betting that the U.S. Central Bank is closer to pausing interest rate hikes in their program of tighter monetary policy. If the Fed doesn't cooperate with that assumption, the dollar could resume its rise. That would be bad for stocks. 

I still think the markets are getting ahead of themselves. If we do hit 4,300 or more on the S&P 500, we would be up 12% for the year. If you add in dividends, it is probably closer to 15%. The market would then be trading at 19.5 times earnings. That appears a little too expensive for me unless the bulls are right--the Fed pivots and begins to cut rates by this summer.

I am hearing just the opposite. Some Fed watchers are upping their target for the terminal interest rate the Fed is targeting from 5% to 6%. Some Fed officials are now hinting that might be necessary to get inflation down to their target 2% rate. If so, that flies in the face of investors' expectations that the fed won't be raising interest rates after their March meeting. No one knows for sure, which gives the markets a window of opportunity to continue to rally.  

My take is that if the technical charts are right, and the markets continue to rise, I am happy to go along for the ride, but I wouldn't be chasing stocks at this point.

Bill Schmick is a founding partner of Onota Partners, Inc., in the Berkshires.  Bill’s 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 e-mail him at bill@schmicksretiredinvestor.com .Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal.