...Dow futures now down another -345pts as I write this, which is rather concerning and portends a bad start for the markets as we move into the new year.
...I hope we don't get a Max Bearish outcome as Jim indicates; we could well see that 5-10% correction from the peak to 5500 for the S&P500 as I indicated a week or two ago. Beyond that depends on whether expectations of Trump 2.0 post inauguration pans out worse than currently expected or surprises to the upside. We should expect some of those concerns to be somewhat factored into this 5-10% correction. Obviously if a trade war is the outcome, then we could go beyond 5-10%.
...2024 ended without the Santa rally that many had expected post-Trump election victory. The Trump exuberance petered out when the Grinch stole Xmas.
I’m not a big believer in making price forecasts for the upcoming year because as the old Yogi Berra saying goes: “It's tough to make predictions, especially about the future.”
However, I do think it’s possible to look at the current structure of the market and attempt to decipher some potential scenarios.
With that said, I will lay out three scenarios to consider: a) Max Bullish, b) Max Bearish, and c) Somewhere In Between.
In all three scenarios, I will use the S&P 500 as our proxy for “the market” and I am using the weekly time frame on the charts. Note: the goal with these scenarios is to provide potential price targets, not timing. These scenarios could play out over the course of weeks, months, quarters, or years. Scenario #1: Max Bullish
Regular readers know I have been calling for a market top of 6,118.
The Max Bullish scenario looks at 6,118 and laughs on its way to 7,742 or ~30% higher than Friday’s close.
The market never moves in a straight line so there would be pullbacks along the way but the ultimate destiny would be somewhere in the neighborhood of 7,742.
It may be stating the obvious, but this scenario cannot be true without a close above 6,118 so that has to happen first.
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Scenario #2: Max Bearish
The Max Bearish scenario would suggest that my 6,118 top call is fairly close to correct and that the move lower has already begun.
Again, markets never move in a straight line so in this scenario, the market retraces back to the 78.6% Fibonacci (4,050), rallies back a bit, and then has a final flush lower.
In this scenario, the target becomes 3,288 or -45% lower from Friday’s close.
The extreme version of this scenario is a target of 2,021 or -66% lower from Friday’s close.
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Scenario #3: Somewhere In Between
Lastly, let's consider a third scenario which is “Somewhere In Between” the “Max Bullish” and “Max Bearish” scenarios.
In this scenario, the 6,118 top is only a temporary top and we see the market trade lower, only to trade higher from there.
More specifically, we see a pullback to the 61.8% Fibonacci (4,488) and then an acceleration to a target of 7,096.
While the ending target is higher than current prices, you still have to manage a -25% drawdown (5,970 —> 4,488), only to be followed by a 58% increase (4,488 —> 7,096).
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Opinions…Everyone Has One…
This newsletter has thousands of readers each week and each of those thousands of readers will likely have their own opinion as to what the S&P 500 may or may not do over the next 12 months.
I’m not suggesting that my opinion is any more valid or correct than anyone else’s, I’m simply trying to put a stake in the ground, using technical analysis, to create some bookends for potential outcomes.
Are you bullish? Bearish? Or somewhere in between?
This is an important question to ask and answer for yourself because it has direct implications for how you may consider positioning your portfolio. Correlation & Beta
In the table below, I have posted the historical correlations & betas of the major US equity sectors relative to the S&P 500.
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Investopedia defines correlation and beta as follows: Correlation - “The correlation coefficient is a statistical measure of the strength of a linear relationship between two variables. Its values can range from -1 to 1.
A correlation coefficient of -1 describes a perfect negative, or inverse, correlation, with values in one series rising as those in the other decline, and vice versa.
A coefficient of 1 shows a perfect positive correlation, or a direct relationship.
A correlation coefficient of 0 means there is no linear relationship.” Beta - “A beta coefficient shows the volatility of an individual stock compared to the systematic risk of the entire market. Beta Equal to 1: A stock with a beta of 1.0 means its price activity correlates with the market. Beta Less than 1: A beta value less than 1.0 means the security is less volatile than the market. Beta Greater than 1: A beta greater than 1.0 indicates that the security's price is theoretically more volatile than the market. If a stock's beta is 1.2, it is assumed to be 20% more volatile than the market. Negative Beta: A beta of -1.0 means that the stock is inversely correlated to the market benchmark on a 1:1 basis.”
The correlation values in the table above range from 0.560 to 0.919 and note that they are all positive.
Very simplistically, this suggests that when the S&P 500 moves higher, these sectors tend to move higher (to varying degrees) and vice versa.
We know that this is not true all of the time; however, given a big enough slice of history, that has been the tendency.
Now let’s shift to the beta values in the table. They range from 0.614 to 1.215.
Again, very simplistically, this suggests that the Technology sector has historically been more volatile than the S&P 500 while the Utilities sector has been less volatile.
A very crude way to handicap potential sector moves relative to the S&P 500 would be to say if the S&P 500 is up +10% over the next year, the Technology sector may be up +12.15% (i.e., 10% * 1.215)
Conversely, if the S&P 500 declines by -10% over the next year, the Utilities sector may be down only -6.14% (i.e., 10% * 0.614).
Again, this is an oversimplified, back-of-envelope, calculation. It is completely possible that something different happens but I am using this example to make a point.
The point is, if you are in the “Max Bullish” camp, history would suggest that you should skew towards being allocated to the sectors that have a beta of greater than 1.0.
Alternatively, if you are in the “Max Bearish” or “Somewhere In Between” camps, and may have to contend with a downturn of some degree, you might be well-served to be skewed towards sectors that have a beta of less than 1.0.
