Chart Advisor: Waiting For the Trifecta

By John Kolovos, CFA, CMT

1/ Trend is Supportive for Stocks

2/ The Path Higher For 2024 Will Likely Be Back End Loaded

3/ Momentum Trifecta is Currently Negative

4/ Sector Rankings Have Financials, Tech and Industrials on Top

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1/ Trend is Supportive for Stocks

At the beginning of 2023, we expected that the bear market “too, shall pass” for the S&P 500 and felt that the journey ahead would be fraught with tremendous uncertainty and volatility.  The bear market low struck in Oct ’22 was anticipated from that year’s Roadmap (a composite of market cycles) and supported by historic oversold conditions and bearish sentiment.  As a result, our best guess for 2023 was 4220, or a 10% gain, with the upper end at 4825.  As it turned out, the index closed within the upper end of our forecast.

As for 2024, the central tendency or “technical fair value” is 4890, just 3% from recent levels, with the high end at 5280, or 11%.  My method for arriving at a “target” is based on the trend itself.  By using linear regression methods, I combine both the secular trend (generational) and cyclical trend (one to two years) to arrive at my “best guess” for the upcoming year. Given the late cycle characteristics coupled with still poor market breadth, we expect sustained gains beyond those levels will be challenging and could likely split the difference at about the 5,000 mark.  As for the downside risk, 4230 is the low end of our range, and as long as the 200-week moving continues to support prices, we can give the bull market the benefit of the doubt. But let’s be honest, as a trend follower, it is nearly impossible to come up with a target because the whole point of following trends is to ride it as long as possible, even if it surpasses all targets and forecasts, and to cut losses short even if expectations aren’t met.

2/ The Path Higher For 2024 Will Likely Be Back End Loaded

The market can take almost infinite paths, but markets follow a consistent rhythm in how they ebb and flow, day to day, week to week, month to month, and year to year. I have found that market cycles can be useful in one’s arsenal to complement other technical tools (trend, momentum, sentiment).  While I would not base an investment decision solely on a cycle, knowing how the market “might” behave creates a useful framework that can help fine-tune positioning at inflection points.  To that end, I combine the annual seasonal pattern of the S&P 500 with the four-year Presidential as well as the decennial cycle that measures the performance of years ending 1, 2,3, 4, and so on.  When we combine all three, we have a Roadmap for the coming year, which suggests a few things in 2024.  One, gains will be hard fought but back-end loaded. Presidential election years are notoriously choppy (as well as years that end in 4), and it is not until the post-election and the mid-terms that the cycle becomes problematic. The other standout is that instead of selling in May and going away, the Roadmap suggests buying weakness in the May/June time frame.  Time will tell if this is how the market will go, but just as important as knowing how the market might behave will be if it deviates from the script.

3/ Momentum Trifecta is Currently Negative

Momentum is the only leading indicator in technical analysis.  Trend following by very definition is a lagging framework, albeit the most powerful.  But to improve on the “technical mosaic,” momentum serves as a confirmation tool, and it can help identify potential turning points all in an effort to fine-tune how one navigates with an established trend.  There are serval ways one can measure momentum, and the most common is that of a rate of change measure.  However, unconstrained oscillators are hard to use systematically, so folks prefer using an RSI or stochastic.  I prefer combining top-down and bottom-up momentum measures to help me assess the equity market.  By that, I mean, what is the momentum of breadth (advancers vs declines), what is the momentum of volume (up volume vs down volume), and what is the momentum of price itself (MACD)?  After all, we should measure the momentum of what is driving the index and the index itself.  Most folks rely on price momentum alone, but I found over 20 years ago that by using a “Trifecta” of momentum, we can see when the market is in gear.  When all three are in sync, we have either a “Trifecta Buy” or “Trifecta Sell”.  The momentum Trifecta model is in sell mode and has been since December 27, 2023.  The good news is it is inching close to oversold levels, but buying oversold conditions alone can be dangerous.  While the trend is positive, and oversold conditions should be used opportunistically, one should wait for momentum to reverse higher before taking sizeable action.

4/ Sector Rankings Have Financials, Tech, and Industrials on Top

As I wrap up my weekly writings, I want to end it with where I rank the equity market sectors.   In short, my work currently favors Financials, Tech, and Industrials while avoiding Staples, Energy, and Utilities. This is mostly a pro-cyclical framework and is consistent with my market observations.  Having been on the buy side, my main objective was to pick stocks, not to make market calls.  Therefore, my ranking process is systematic and bottom-up.  What that means is that the technical model I developed 20 years ago, which incorporates Trend, Relative Strength, and Money Flow, is applied to each stock in the Russell 3000 and then aggregated to the sector level to arrive at the sector rankings. This process removes market cap bias and forces me to only look for long ideas where the trend is positive while avoiding (or even shorting) those that are in downtrends.  While it is beyond the scope of these writings to go into detail as to how to develop a ranking system, if one uses a systematic means to measure a stock’s technical strength, which removes human biases, keeps you on the right side of the market, and then focuses on only those with favorable trends within a risk-controlled setting, then one can have a fighting chance to achieve alpha generation.  When the technicals line up with the fundamental outlook, then 1+1 can equal 3.

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Originally posted 19th January 2024