Good evening:

"Markets trend only about 15% of the time; the rest of the time they move sideways" - Paul Tudor Jones

In recent weeks, Tom Lee has noted that many clients are puzzled by the scorching market rally to kick off 2023. As inflation continues to fall, the Nasdaq posted its best start in 31 years. Rarely have markets been this resilient. Rarely has there been this much cash still on the sidelines. 

“People might say, ‘Well, earnings still need to fall,’” Lee said Thursday. “Yet (the S&P 500 Index) is producing its fifth-best gain ever through day 26 … And so, we have a table here to show that if you look, through day 26, at all instances where the market went up more than five percent, the median further gain into the end of the year is 16%, and only one of the 17 instances did the market actually decline, which is 1987. So, unless you think this is 1987, the S&P is on track to end the year above 4,800.”

Lee’s research aligns with that of Mark Newton, our Head of Technical Strategy, who has relied partly on seasonal trends and cycles to forecast major market moves. Since the fall, we’ve shared the power of understanding the presidential cycle and its impact on markets. Last year was the 21st midterm election year since 1939. Newton has repeatedly noted that there has never been a negative return from the midterm election to June 30 of the following year. Six times, the returns from the midterms until June of the next year were greater than 20%. 

In the four years of a presidential term, market returns are usually weakest in year two of that cycle, which was 2022. The worst quarter of the 16 quarters is year two, quarter two, so 2Q 2022 again seems to have followed the pattern. The best quarters are the fourth quarter of the second year through the second quarter of the third year. In this case, that’s Oct. 1, 2022 through June 30, 2023, generally, the sweet spot for market returns, mainly because investors look past the uncertainty around the midterm elections.

At least so far, since the mid-October lows, the market has performed true to this trend, like clockwork. While a February pullback or cool-off is likely, the subsequent few months are positive. Newton also notes that momentum and breadth have improved substantially since the fall. European and Asian markets are performing well. Plus, investor risk appetite remains low, and cash positions remain elevated, which makes Newton believe we’re in a new bull market. “This doesn’t mean we’ll go straight up,” Newton said. “We haven’t reached bullishness yet. It’s a market that respects that inflation is falling. Cyclically, we’re in a nice spot.”

Added Newton: “I have Bloomberg on in my office most of the day, and everybody is in disbelief and publicly questioning, ‘How in the world, the markets can’t rally?’ The labor market is hard to understand, but markets keep rallying, and people need to respect that…Seasonality suggests we are due to slow down, so I think the back half of the month could be choppy. But we’re on track to continue rallying, I think until March. That’s when yields and the dollar bottom, maybe we have a pullback between March and May.”

A quick glance at earnings

Adam Gould, our head of Quantitative Strategy, pointed out that this earnings season has seen the gap between the performance for earnings beats and the declines for earnings misses narrowing sharply from last quarter's. "To me, this means a lot of idiosyncratic risk is coming out of the market,” he said. “It's becoming more of a ‘rising tide lifts all boats’ kind of thing.”

Last Friday’s surprisingly strong jobs report remained on investors’ minds over the weekend, leading to a weak beginning to the first full week of trading in what is traditionally a weaker month for markets. The fear was that the Fed would see the numbers as reason to get more hawkish, but Lee was not worried. “It took the Fed three great inflation reports (below expectations) before Fed acknowledged ‘disinflation,’” he noted, so why would one strong jobs report cause the Fed to suddenly accelerate hikes?

And he was right. In his Tuesday speech, Powell kept the narrative unchanged. “The disinflationary process, the process of getting inflation down, has begun. [...] We expect 2023 to be a year of significant declines in inflation. It’s actually our job to make sure that that’s the case.”

As Lee has noted, February is particularly weak in years preceded by a negative year (like 2022). But given January’s strong performance, 2023 is expected to be a positive return year:

More AI

Amid the hubbub of ChatGPT, Microsoft rolled out an improved version of its Bing search engine. Satya Nadella told CNBC that AI-powered search is the biggest thing to happen to the company in his nine years as CEO. “I have not seen something like this since, I would say 2007-08, when the cloud was just first coming out,” Nadella said. It’s apparent that big tech’s race to capture the AI market is well underway, with no shortage of opportunity, challenge, and competition. 

Not to be left behind, Alphabet announced that it planned to unveil a rival chatbot named Bard “in the coming weeks.” That proved to be at least a near-term disaster that erased as much as $100 billion from the company’s market cap on Wednesday, after Bard gave an incorrect answer to a question about NASA’s James Webb Space Telescope at a press event. The AI technology on which both companies’ tools were built has long been known to be prone to “hallucinating” false information. It can also perpetuate racial and gender biases (including hate speech) scraped from the Web. 

Elsewhere

The devastation of the earthquake that struck Turkiye and Syria continues to deepen. Amidst the widening tragedy, the Turkish stock market halted trading this week. Oil prices also pushed up this week over concerns about interruptions to the flow of Azeri and Iraqi crude, which go through the Ceyhan export terminal hub that has been shut down for precautionary reasons. 

The French continue to protest their president’s efforts at raising the country’s retirement age from 62 to 64, with a third day of strikes on Tuesday and fourth scheduled for Saturday. 

The UK Treasury and the Bank of England began consultation on a state-backed digital pound on Tuesday, looking into a less volatile, fiat alternative to other digital currencies. No decision on the matter was expected until at least 2025.

Kazuo Ueda is reportedly slated to be named the next governor of the Bank of Japan, replacing Haruhiko Kuroda when his term expires. Dr. Ueda, an economics professor and former classmate of Ben Bernanke’s at MIT, was a surprise pick after current Deputy BOJ Governor Masayoshi Amamiya reportedly turned down the job.

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