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Stocks Show Resilience, Sprint Back To New All-Time Highs

The S&P 500 gained 1.94% this week with Friday's close at 3,841.47.

Friday's close is a new all-time high weekly close for the index. In last week's Update we wrote:

"...the odds slightly favor the market showing resilience and heading back toward all-time highs over the week ahead." 

Thankfully, that's what we saw this week! The S&P 500 came out of the gates strong on Tuesday and never looked back. The index recorded its weekly low shortly after the weekly open, and if not for Monday being a holiday we would have set our weekly low on Monday yet again.

From a chart pattern perspective, the 20-day simple moving average continues to appear as magical "support" to the price of the S&P 500 (note the blue arrows below). The rally has now extended to levels where even a standard -10% correction would leave the index back retesting our prior all-time highs, which stands as a tremendous confluence of perceived support (red shaded region).

Another week in the books, and another weekly advance of 1% or more for small-cap stocks.

The iShares Russell 2000 index fund (ticker symbol IWM) gained 2.02% this week with Friday's close at $215. Friday's close is a new all-time high weekly and daily close for IWM.

IWM has now increased eleven of the last twelve weeks, gaining 40.88% in the process. Remarkably, IWM has gained 1% or more each of the eleven weekly gainers over the last twelve weeks. IWM's 40.88% gain the last twelve weeks is the second largest twelve-week return for IWM since its inception, falling short of 05/29/2009's twelve-week sprint of 43.02%.

IWM is incredibly "overbought" in the short term. This is a sign of tremendous buying interest across the actions of market participants, and while it generally means a retracement is in order in the short term it is also suggestive of higher prices for IWM over the intermediate term. We don't expect the next twelve weeks for IWM to look anything like the last twelve, but we do believe IWM will trend higher over the course of 2021.

From a sector perspective, this week was a total opposite to last week.

The traditional market capitalization weighted S&P 500 easily outpaced the S&P 500 equal weight variant. Naturally, the S&P 500 technology sector absolutely roared this week, gaining 4.25%. The communications sector (the sibling of the technology sector) gained 5.44% and the consumer discretionary sector gained 2.59%. All of the other eight sectors within the S&P 500 actually underperformed the S&P 500 this week, with materials, energy, and financials all declining more than -1% for the week. 

This is straight out of the peak COVID playbook, as the price action during the height of the pandemic last year was an all or nothing trade where technology and consumer discretionary stocks were marching higher and everything else was lagging behind. Netflix (NFLX) price action this week illustrated the point well. NFLX gained 13.49% this week and emerged from a roughly seven-month base as if we're all still doing nothing but binge-watching over the months ahead.

We're not sure why there was such a sharp, fast rotation back toward the COVID trade this week, but we're never truly sure of the "why" behind any market move. The rotation back toward technology this week just cements the idea we discussed last week: 

"The bifurcation of COVID continues to manifest itself in somewhat of an all or nothing aspect to internal market behavior. Either technology does well and everything else lags, or everything else does well and technology lags. Given the uncertainty surrounding COVID in the back half of 2021, this is why we value a diversified "barbell" approach toward equity ownership at the moment."

For this past week, it was the technology side of the barbell that did the heavy lifting. For next week, maybe it will be everything else that does the heavy lifting. While we'd prefer uniformity in market internals, there is an element of "next man up" in the way the market is playing, and that's an attribute of any and all great teams. Look no further than Chad Henne playing a role in why the Chiefs are playing today.

So, as long as the sector dispersion in the COVID bifurcation trade remains favorable, then the S&P 500 can keep on winning. Hopefully the index can finish the month of January on a positive note.

S&P 500 Primary Trend - Up

Our work continues to label the primary trend for the S&P 500 as up or "bullish".

There are five trading days remaining in the month of January, and the month is presently higher by 2.27%. If January can hold on to finish the month in positive territory, the S&P 500 will record a three-month winning streak over the "turn of the year" period which is always a good omen forward-looking (more on this below).

The index is presently higher by 17.48% the last three months - just as we all expected at the end of October right in front of the election (sarcasm) - and we can count on one hand the number of three-month periods that gained 17.48% or more over the last 40 years.

It's been an incredible price thrust the last three months. Eager buying interest to this degree in the present can only be a derivative of market participants, collectively, having conviction in the idea of higher prices into the future. Ultimately, this conviction isn't always proven to be correct, but it is correct far more often than it's wrong. The most prudent plan remains to "be right and sit tight", regardless of how compelling the "bearish" narrative is at the moment.

Long-term readers know we're huge fans of Wayne Whaley. He's sort of the "OG" of market quants. Almost a decade ago Wayne published his "Turn Of The Year (TOY)" indicator, and we've tried to help popularize it over the years as it's been a valuable compass for the future price action of the S&P 500.

For those of you who are unfamiliar with the TOY indicator, click here to read an article we wrote about it in 2015 for See It Market. For those of you who are familiar with the TOY indicator, we have good news to share: the S&P 500 ended 2021's TOY window higher by 6.22%, squarely in the "bullish" camp.

"Bullish" TOY readings have seen the S&P 500 close higher one year later (i.e., the S&P 500's one-year return from 1/19/2021 through 1/19/2022) an astounding 34 out of 36 times for average returns of 16.40%.

The two losers were both derivatives of market crashes (2018 and 1987), but neither saw the index decline more than -7.43%. So, quantitatively speaking, don't be so quick to believe "this can't continue". It absolutely can continue and it can leave you in the dust if you're not disciplined.

U.S. Dollar Index Hanging On By A Thread?

The U.S. Dollar Index (DXY) declined -0.60% this week with Friday's close at 90.21. DXY has been in a decided downtrend since March of 2020 but has also been mostly range-bound for the last 5 years, oscillating between the ~103 and 88 levels. 

Interestingly, the price action for risk assets like the S&P 500 has tended to do much better when DXY is falling from ~103 down to ~88, not when it's been climbing from ~88 to ~103. It's through these lenses where DXY's future price action is critical, especially as it seems to be trying to find support at and around the ~88 region.

It's clear a falling DXY is beneficial to the international equity markets, specifically the emerging markets.

The MSCI Emerging Markets Index (MSEM) has been almost as hot as small-cap stocks. MSEM has broken out to decided new all-time highs and, like IWM, has increased eleven out of the last twelve weeks. MSEM is incredibly "overbought", and in any scenario where DXY holds support in the ~88 region and reverts back toward the ~95 region, it's reasonable to expect volatility in MSEM (and probably IWM too!).

Finally, expanding our view on DXY reveals that any breakdown below the ~88 region, even if it occurs after a rotation back into the mid-90s, will probably be a boon to risk assets. Any break below ~88 and DXY is probably taking the next set of stairs down to the ~78-84 region.

From a fundamental perspective, we have absolutely no idea why DXY wouldn't trend down toward the ~78-84 region in 2021.

Through technical lenses, it's hanging on by a thread here in the short term. Through fundamental lenses, dollars are being printed and spent like they're burning a hole in our pocket. And through sentiment and/or psychological lenses, if the world is "risk-on" and the DXY represents the ultimate safety trade, then why shouldn't we expect DXY to trend lower over time? 

From a cross-asset class relationship perspective, it just feels like the DXY is headed lower over time and the S&P 500 is headed higher over time. We may see counter- trend moves in the short term, and that might finally bring a pause to the rally in risk assets we've seen the last two-plus months, but the evidence as of today suggests that reversion will be temporary. It will only temporarily interrupt the primary trends of DXY and SPX...it won't end them.

Time will tell if we're correct. As always, we'll be excited to watch.

Happy Sunday!

Steve & Rick

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