Stocks Sprint Through The Finish Line

Happy New Year! We hope you had a wonderful holiday weekend, and we look forward to a good and healthy 2022 for you and yours!

The S&P 500 gained 0.85% this week with Friday's close at 4,766.18. Friday's close is a new all-time high weekly close.

The index opened the week flying higher on Monday, closing the session at 4,791.19. We then traded to a new all-time high at 4,807.02 on Tuesday, a new all-time high daily close at 4,793.06 on Wednesday (our 70th new all-time high daily close of 2021), and another new all-time high on Thursday at 4,808.93. Minor selling pressure emerged on Friday to finish off the week in the red. The index has now gained 4.33% over the last 8 trading days spanning back to Monday, December 20th's close at 4,568.02. Clearly, Santa brought all the presents this year.

The main takeaway from the price action this week was the S&P 500's "breakout" to new all-times.

The breakout isn't confirmed as of yet, but it does appear that the index scored a touchdown this week as the ball looks to have crossed the goal line and the referee raised his arms. The price action next week will provide the answer to the "upon further review" that's required to know if the call on the field stands.

Quantitatively, the "3% rule" and "4-day rule" are our favorite ways to objectively define the word breakout. The "3% rule" requires a trade up to ~4,886 to confirm a breakout while the "4-day rule" basically requires the index to close above ~4,740 each and every trading day this week. 

Should both occur, then it's a safe bet that the highest prices in the history of the S&P 500 didn't bring eager selling pressure into the marketplace (i.e., "resistance" didn't emerge). It would be even more ideal if the S&P 500 traded down into the ~4,730s on Monday or Tuesday, only to then trade up in the ~4,800s on Friday. That would mark the presence of eager buying interest immediately following this week's trade up to new all-time highs, a picture-perfect sign of "accumulation". 

Sector performance was interesting this week as seven of the eleven sectors within the S&P 500 gained 1% or more for the week, and four of those seven gained 2% or more this week. Real estate was the big winner this week, gaining 3.79% to cap off an incredible month (more on this below). On the surface, one would assume the S&P 500 roared to the upside this week.

But with the S&P 500 only adding 0.85% the obvious takeaway is that its two largest sectors (technology and consumer discretionary) didn't do all that much. Technology gained just 0.54% while consumer discretionary added 0.62%. This is a curious recipe as there remains somewhat of an on-off switch with market internals; either technology and discretionary perform well and everything else underperforms, or everything else does well and technology and discretionary underperform. 

"Breadth" is improving somewhat, but we're still a long way away from the whole team playing well together simultaneously.

Should this on-off switch persist into 2022, there exists the possibility of the S&P 500 crawling to the upside while the smaller sectors are sprinting to the upside. This would be a stark contrast to the last five years.

Taking the number of stocks that closed Friday above their 50-day moving average (50MA) as an example, just 354 of the ~500 stocks within the S&P 500 closed above their 50MA on Friday. By contrast, we've seen peaks well above the 400 marker over the last few years. That's when the team is really rocking and rolling.

So we're on to 2022. It's a new year, but it's a pivotal week and there's a ton of market-moving economic data coming forward to kickoff the new year. We'll get PMI on Monday, ISM on Tuesday, FOMC minutes on Wednesday and the jobs report on Friday. 

We continue to believe the economy is strong, and a recession isn't probably here in 2022, so if this week pairs together strong economic data with new all-time highs for the S&P 500 then we'll have more evidence that the S&P 500 is going to cross the 5,000 region in the first quarter of 2022. Hopefully the call on the field is confirmed.

S&P 500 Primary Trend - Up

The S&P 500 put 2021 in the books on Friday and it was another fantastic year for the index.

The S&P 500 gained ~26.89% in 2021 (28.7% when including dividends), its third consecutive double-digit yearly advance. The index gained 4.36% in December, its best December since 2010. We've now seen the S&P 500 set a new all-time high each and every month for fourteen consecutive months, a streak we've only seen two other times in the history of the index (August 2014, April 1955). The index is also streaking on the quarterly time frame, having just increased for the 7th consecutive calendar quarter and gaining 84.41% over the same time frame. That's the single best seven-quarter return the index has ever produced, and by a wide margin.

All year long we wrote that "this can continue", reiterating the idea that the S&P 500's stellar performance the last few years wasn't a sign that things needed to slow down in 2021.

Thankfully, the index sprinted right through the finish line. Our mantra is not going to change for 2022; the S&P 500 can continue to move higher and climb the proverbial "wall of worry". 

Interestingly, there are a lot of people we converse with who believe the S&P 500's advance in 2021 is/was "too good to be true", which generally implies this can't continue. We imagine some of our readers feel this way too, and we can't really blame them. It's human nature to believe what goes up must come down, especially after it's gone up this much.

Importantly, we have absolutely no idea if this will continue, and we can't predict the future. But we are absolutely certain that that S&P 500's yearly return in 2021 isn't a sign that it can't continue.

There are very bright, articulate arguments against the S&P 500's performance here in 2022. From the Fed tightening, to the economy slowing, to geopolitical risks rising, to the uncertainty surrounding inflation and midterm elections...not to mention that we're still in a global pandemic. Note what doesn't make the list though - the S&P 500's return in 2021.

We also note that the S&P 500 gained 10% or more in the fourth quarter of 2021 while also closing the quarter at a new all-time high quarterly close.

We'd be remiss in not pointing out the Decembers on the table above, or all other fourth quarters that gained 10% or more and closed at a new all-time high quarterly close like we did here in 2021. That brings us to Decembers of:

2020

1999

1998

1985

1982

1958

1954

Excluding 1999, the S&P 500's performance the very next calendar year was fantastic in all of the above instances.

As we head into 2022 we've all got 99 problems, but the price action in the S&P 500 isn't one.

(At least not yet...)

Supposed "Defensive" Sectors Go Nuts

There are sectors within the S&P 500 that conventional wisdom deem to be "defensive". They've earned this label based on their historical tendency to perform relatively well during volatility storms, or "bear markets", for the S&P 500. In other words, when the S&P 500 is in a "bear market", a "defensive" sector like the utilities sector is expected to outperform the technology sector. We believe this is a fair expectation, but what about the idea that extreme outperformance from the "defensive" sectors today is a sign of a volatility storm tomorrow? We find ourselves asking this question because of the extreme outperformance the "defensive" sectors of the market produced in December.

Consider the following "defensive" sector returns in December:

Consumer Staples: 10.45%

Utilities: 9.69%

Healthcare: 9.02%

Safe to say, the "defensive" sectors took off to the upside in December like a rocket ship.

Market participants, collectively, were bidding the "defensive" sectors like mad in December. And since the "defensive" nature of these sectors has to do with these companies being able to maintain profitability during economic contractions, we couldn't help but wonder if what we saw in December, collectively, was the market's way of expressing growing concern about the economy in 2022.

Zooming in on the consumer staples sector (which is a bellwether of the "defensive" sectors) as measured by the SPDR's Consumer Staples Select sector ETF (ticker symbol XLP), we can identify 19 prior calendar months where XLP gained 5% or more. A quick glance at the table tells the story, and the overabundance of white suggests that when market participants, collectively, are eager to own the consumer staples sector it hasn't been a prescient sign of a volatility storm for the S&P 500.

If we add an additional filter and try to measure not only calendar months where XLP gained 5% or more, but months where XLP also outperformed the consumer discretionary sector (ticker symbol XLY), an effort designed to show not only eager buying interest for "defensive" stocks but also a preference of "defensive" stocks over economically sensitive stocks, the picture doesn't change.

So, the answer to our question is when the "defensives" go nuts to the upside in the present it's not a sign that you truly need a defense into the future.

Happy first Sunday of 2022!

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