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The Energy sector emerged as the top performer for January, a nice respite after a terrible 2020—but not exactly a good omen. Unlike in horse racing—where the concept of “early speed” has significant predictive power—the early leader in the sector-performance sweepstakes hasn’t reliably followed through in the last 30 years.

For decades, stock market observers have viewed January’s action as a harbinger for the rest of the year. Is there any merit to that belief?  

Early evidence suggests the Biden administration and the newly “purple” Senate will resist the pull of the far-left, at least from an economic perspective. Stock investors are cheering... though in light of their current euphoria, they might as well have celebrated a write-in victory for Ralph Nader alongside Green Party control of the Senate.

The January moves in heavily shorted Micro Caps were more bizarre than anything we saw during the wildest days of the Tech bubble. Despite these signs of rampant stock speculation by the retail crowd, we still wouldn’t characterize today’s sentiment backdrop as frenzied as the peak levels of 1999-2000.

With yields on the 10-Yr. Treasury finally breaking above 1.00% last month, the consensus has quickly evolved to the view that stocks and yields can continue to rise alongside one another for a while. Small Caps have shown a decisive performance edge during the recent episodes.

The recent months’ surge in Small Caps has been historic, and the Russell 2000 continues to register ridiculously “overbought” readings on many technical oscillators. In the short-term, that might be a cause for caution on the overall market. However (and perhaps counter-intuitively), this extreme strength cements our view that a long-term leadership cycle in Small Caps is underway. 

Stock market valuations may be considered the ultimate in fundamental measures, but they can just as easily be considered long-wave sentiment indicators. What causes equity investors to pay as little as 10x for S&P 500 Normalized Earnings at one point (March 2009), but pay more than 30x a dozen years later? The Fed printing press was in overdrive at both points; only emotions can account for the difference.

When investors ponder the level of yields that might pose a problem for stocks, it’s invariably the U.S. 10-Yr. Treasury bond that’s referenced. That’s fine, but the middle part of the Treasury curve has had just as strong a relationship with stocks, historically, as have longer-dated bonds.

The sell-side is at it again, publishing a one-year ahead “Adjusted” EPS figure for the S&P 500 that is unlikely to be achieved—and then affixing P/E multiples seen near an historic market peak to “capitalize” on those unlikely earnings.

Equities continue to benefit from an odd combination of faith and doubt in the Federal Reserve: Faith that the “Fed put” under financial markets is struck closer to the price of the “underlying” than ever before, and doubt that limitless liquidity will trigger a dangerous rise in consumer prices. In all fairness, this glass half full assessment is hardly a theoretical one, but one based on years of empirical evidence. 

Move over, Y2K! In late January, the squeeze of popular hedge fund “shorts” eclipsed anything we saw at the peak of the Technology bubble. But who knows? An even wilder event might be in store in coming months.

Read this week's Major Trend.

The Redditors came for the hedge funds, and chaos ensued. We think that when the dust settles, the Reddit crowd will be the spark that allowed more powerful market players to inflect the real pain. Our thoughts, from experience, on why this happened and how we try to avoid it.

The Equal Weighted S&P 500 has clawed back most of its enormous return deficit. The one-year trailing return favored the Cap Weighted measure by +13.5% at the end of August—the widest rift since we exited the Great Recession. As of the end of January that gap had been whittled down to +3.5%.

Both of the Small Cap styles had a terrific start to 2021 as each gained +6.7%. Small Cap Growth is now the best-performing style box since the end of 2019 (+44%).

Our Ratio of Ratios has rocketed toward its historical median over the last two months. Over that time, the Russell 2000 (+14%) has absolutely trounced the S&P 500 (+3%). Buying Small Caps over Large on a relative valuation argument can still be made—but that window seems to be closing quickly.

As we kick-off Q4-20 earnings reports, our Up/Down ratio reads 2.19. We’re a bit surprised to have such a strong number given that the YOY look-back hurdle is pre-pandemic.

We remain favorable toward credit including investment grade and high yield corporates.

We look at the recent short squeeze and examine how these populist movements affect the market performance in populist vs. establishment countries, and dig deeper into the regional versus sector effect.

Financials jumped from 5th place to 1st this month—the first time Financials has been the highest-rated since February 2020. Information Technology, Consumer Discretionary, and Communication Services round out the top.