Last week, I spoke about the historical precedent of having a good start to the calendar year for the stock market...
In particular, I discussed the "first five days" rule which says that if the stock market is positive during that period, then it has a higher-than-normal likelihood of being up for the year.
If the market also ends up for the month of January, then that would be an even more powerful signal, per the "January effect," which I also noted last week.
In addition to these indicators, we have another rare but powerful technical signal – one that could portend very strong returns for the year ahead...
This signal was called out by several technical analysts, notably Todd Campbell in this article from TheStreet.com.
This signal is called "breakaway momentum" and was coined by legendary long-term technical investor Walter Deemer.
The signal measures the ratio of advancing versus declining stocks across a 10-day period, and a ratio of 1.97 times or greater is considered to trigger the signal. This means that two-thirds of stocks are going up versus down for two full trading weeks.
Here's what Deemer himself had to say about this signal (emphasis added)...
Downside momentum usually peaks at the end of a decline, as prices cascade into a primary low. On the upside, though, momentum peaks at the beginning of an advance, then gradually dissipates as the advance goes on, and the more powerful the momentum at the move's beginning, the stronger the overall move; really strong momentum is found only at the beginning of a really strong move: a new bull market or a new intermediate up leg within a bull market. We coined the term "breakaway momentum" in the 1970s to describe this really powerful upside momentum.
The good news is that the year-to-date rally in stocks has come in at a 10-day ratio of 2.16 times, triggering the signal for only the 25th time since 1949.
The key for Deemer was not just the number of stocks going up but also the low number of stocks going down. Here is what he said...
The real trick in generating breakaway momentum? It's not a lot of advances; it's a lack of declines. If the market stages a strong two-day advance, for example, it must maintain very positive breadth days for a couple of days afterward to keep the 10-day declines to a minimum. Also, declines must be kept to a minimum during the "normal" correction in the middle of the 10-day period; declines can exceed advances during those two days, but not by much or it will be impossible for the market to generate the two advances needed to offset every decline.
So, how useful is this signal?
According to the data Deemer analyzed, this is only the 25th time this signal has been triggered. Across two months and three months, it shows a 92% hit rate... And across six months and a year, it shows a 96% hit rate.
The returns are also outstanding, with the average return of the S&P 500 Index coming in at 20%-plus across a year, or well above the historical average of the market as a whole.
Now, we're sure a lot of folks will say that this time is different and that you can't compare the past with our current situation, which includes inflation and other contrasting macroeconomic variables.
However, looking back at the data, the signal worked well during the inflationary period of the 1970s as well as in 1987 and the global financial crisis in 2009.
The only times it didn't seem to work was way back in 1962 and then especially in 1992.
Something of note, though, is that back in 1992 it did work a year out... And even as it wasn't working, the stock market wasn't going down a whole lot. We think the vast majority of investors would take a flat range-bound market over the debacle of 2022!
In the near short term, the market is looking a little overbought, and we could (and likely should) see a pullback at some point.
The article above, though, mentions a great concept from TheStreet.com analyst Helene Meisler: "Price has a way of changing sentiment."
With this all in mind... what could happen next?
The last time this signal was triggered was back in June 2020. The market had bounced back from the crazy volatility of the COVID period but was not yet back to its old highs.
It would, however, eventually move much higher, but not before a couple of nice pullbacks in June, September, and October.
Something similar will likely play out here...
We wouldn't be surprised to see the market churn higher and for stocks to become even more overbought. At some point in the next few months, we think there will be a great opportunity to accumulate stocks.
The next two weeks are critical, but we're likely closer to the point where the stock market storm will clear and we can all walk outside without an umbrella!
Switching gears, be sure to mark your calendar for Tuesday, January 24...
There, my friend and colleague Herb Greenberg will reveal why 235 cities across the U.S. are set to see a "blackout" in 2023.
But he's not talking about a grid failure or power outages. As Herb tells me...
This is FAR more serious, and – whether you’re in the market or on the sidelines – it could be catastrophic for your money.
January 20, 2023