After a historic rebound in 2020, the question investors are asking the most is are we heading into year-end correction? The short answer is I’m expecting equity markets to begin a correction, or at least a pause, in the early part of 1Q21. However, I caution investors from overreacting to a pending pullback.

As I have mentioned from time to time, Peter Lynch, Fidelity’s star manager of the Magellan Fund between 1977-1990, had excellent advice for investors when he stated “Far more money has been lost by investors preparing for corrections than has been lost in the corrections themselves”.

The important technical point is to build a longer-term perspective to understand the ongoing volatility that develops every year. I rely on three main investment horizons in my investment roadmap. 1) Consider the long-term, secular backdrop. 2) Markets in their current 3-4 year cycle that responds to liquidity controlled by the federal reserve and to economic growth. And 3) what is the tactical, multi-month outlook that tends to respond to the earnings cycle, investor sentiment, and technicals, such as overbought and oversold readings?

1) From a secular trend and cycle perspective, equity markets have ebbed and flowed, rallied and consolidated, around a 17-year cycle. That may seem a bit odd at first glance but these long-term cycles fit well with the demographic and life cycle of each generation. My analysis suggests equity markets are likely in a period of expansion that could last into the early-mid 2030s. If the secular trend that began in 2000 continues, a move to S&P 14,000 is not unreasonable from a technical perspective. Now that’s food for thought…and debate!

2) While the technical backdrop suggests equity markets are in a secular uptrend, those long-term trends tend to ebb and flow around a 4-year cycle. Liquidity and economic growth are the two main catalysts driving these multi-.year cycles and there is a reasonable debate that the US election cycle is an additional catalyst. Regardless, since 1945, a 4-year cycle is sufficiently evident that it would be prudent to incorporate as a factor too. For example, a 4-year market cycles defined the cycle lows during the secular uptrends of the 1950s-1960s and 1980s-1990s and appears to be doing so in the 2010s-2020s. I view the March 2020 low as another cycle low following Q1 2016 low that should carry markets higher through 2021 and likely into 2022. If history is a guide, then the average 4-year cycle rally in a secular bull market of 100-110% which suggests the S&P could reach 4400-4600 by 2022.

3) If my roadmap is correct, a pullback in 1Q1 is likely to be temporary, the proverbial pause that refreshes, and not a major cycle peak. Equity markets have rallied strongly and are starting to move toward overbought levels based on the weekly momentum data.

The first few days and weeks of January are notoriously volatile so I would caution readers from overreacting to headlines too quickly at the beginning of the year. It’s possible equity markets pivot lower early in January but my expectation is for an additional move higher into late January-early February before our weekly momentum data peaks signaling a tactical top.

Sectors: Tech has bounced back from the lower end of its 2-3 month consolidation and is in a broad, 4-month relative performance trading range. The discretionary sector is also bouncing back following its recent near-term pullback with its longer-term uptrend. Cyclicals remain in emerging uptrends with financials above their 50-day relative moving averages, while industrials, materials and energy are pulling back or pausing near their respective rising 50-day relative moving averages. In contrast, safety sectors, such as staples, healthcare and utilities remain in relative downtrends, while materials bounced back after a brief pullback.

Bottom Line: Use pending strength in January to prepare for a more volatile first quarter. If you are highly leveraged trader, reduce risk in anticipation of a bumpier ride in Q1. For longer-term investors, keep some buying powder dry to take advantage of pullbacks into Q2 to increase exposure to cyclical stocks.

Happy New Year and thank you for all your support in 2020!

Figure: Weekly Sector Review
Source: Fundstrat, FactSet

  • Technology has bounced back from the lower end of its 2-3 month consolidation and has recaptured its 50-day moving averages of relative performance leaving it in the middle of a broad, 4-month relative performance trading range.
  • The discretionary sector is also bouncing back following its recent near-term pullback with its longer-term uptrend.
  • Cyclicals have ebbed and flowed lately but remain in emerging uptrends with financials above their 50-day relative moving averages while industrials, materials and energy pull back or pause near their rising 50-day relative moving averages.
  • In contrast, safety sectors, such as staples, healthcare and utilities remain in relative downtrends while materials bounced back after a brief pullback.
The Perspective on a Potential 1Q20 Equity Market Pullback

Figure: Best and worst performance sectors over past 3 months

The Perspective on a Potential 1Q20 Equity Market Pullback
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