This has been a wild year for the stock market. If you’d polled folks in March, virtually nobody would have said that stocks could recover their losses by the end of the year. Not only have the indexes clawed back all of the crash, but they’ve in fact gone on to strong overall gains. As measured by SPDR S&P 500 ETF Trust (NYSEARCA:SPY) stock, the market is up 15% for 2020, and it’s jumped a shocking 70% from the March lows.
The thing to remember with straight-up markets, however, is that you tend to get swift corrections, seemingly out of nowhere, often for very minor reasons. When the market is running up a few percent every month or even week, things get way overbought and then you can get hair-trigger sell-offs due to profit-taking, short-term news blips, or other minor inconveniences.
And, in fact, that’s exactly what we should be looking for in coming weeks. Now, to be clear, markets probably won’t tank tomorrow. The holidays are a generally quiet and bullish period. However, once January hits, start looking out for a sharp market break. Here’s why.
Parallels to 1999
The most obvious analogy to the present day is 1999. That was another market where tech stocks were leading the charge, and investors were thrilled by all sorts of growth companies. You had certain sectors that were on fire, then it was things such as memory storage devices and the Linux operating system, now we have electric vehicles (EVs).
Then, you had initial public offerings (IPOs) coming out and shooting up hundreds of percent virtually overnight. IPOs are red-hot again, and now we’ve added special purpose acquisition companies (SPACs) to the mix. Nowadays, it’s not at all uncommon for an EV SPAC to come out at $10, like, say, QuantumScape (NASDAQ:QS) and then go up to $70 within a few months. That’s shades of 1999 right there.
What’s interesting in relation to SPY stock and the market indexes overall is how things fared broadly in 1999. Consider the tech-heavy Nasdaq during that era. For 1999, the Nasdaq composite surged 86%. In the middle, however, there were four swift 10-15% corrections, all four of which happened within a three-week span from top to bottom. You’d think it’d be difficult to lose money in a year when the market rallied a jaw-dropping 86%, but even in 1999 – the most euphoric of years – there were still repeated sharp drops to shake out the weak hands.
Looking For a Swift Pullback
Given that it’s been quite a while since we’ve had a significant sell-off, we should be on the lookout for one of these sorts of abrupt moves as soon as the holidays are over. Interestingly, CNN’s Fear & Greed Index hit its highest level of the year earlier in December. The index runs from 0 (absolute fear) to 100 (complete euphoria) and rarely goes beyond 20 or 80 to more extreme levels. Earlier in December, however, it nearly got up over 80 This signals extreme investor complacency.
Prior run-ups to the 80 level – including January 2018, September 2018, and December 2019 – all ended with swift and steep sell-offs. There’s no guarantee of a repeat, of course, but the odds favor this current bout of market euphoria ending in a rapid retreat of the 10-15% variety.
Think about it. At that point, President-elect Joe Biden will be inaugurated, market participants will re-evaluate the outlook for stimulus, earnings, and the speed of normalization as the vaccines are hopefully in broad distribution. Quite possibly, the market resumes gliding up to 4,000 and beyond. But we should expect some stiff market volatility in January as the holidays end. Then, investors will make adjustments for the new year and new administration in Washington.
The perfect Christmas gift for yourself could just be some portfolio hedges on SPY stock once we’re into the last week of this year.
The Holiday Effect
On a related note, let’s be clear that fundamentals simply do not matter at the moment. They probably won’t until January. Markets typically go up from November into year-end, with a particular burst around the Christmas to New Year’s Eve week. Two-thirds of all Decembers have been positive dating back to the 1960s, and we’re well on our way to adding another one to the tally this year.
This is due to certain non-economic market dynamics, such as people rushing to invest money before the tax year ends, and funds chasing performance for their year-end returns by buying up stocks ahead of the close. Additionally, professional traders take a lot of vacation time between Thanksgiving and the end of the year, leading to thin trading volume. In thin markets, the path of least resistance is generally with the trend – so, at the moment, that’s higher.
SPY Stock Verdict
This is a great time to enjoy the holidays and come back with a fresh set of eyes for 2021. It’s unlikely that the market is going to do anything drastic over the next couple of weeks, so this is a good time for broader reflections about 2020 and thinking ahead to portfolio adjustments for next year.
That said, don’t get too complacent. The Georgia Senate run-off votes are on Jan. 5. Biden will take office later that month. Throw in any whiff of earnings weakness as Q4 results start rolling in, and the market and SPY stock could drop in a hurry. Remember 1999; even in the best of times, the market still regularly dropped 10-15% in quick painful retracements.
There is a ton of frothiness out there right now, and it’s times like these where markets have a tendency to suddenly dive lower out of nowhere. If you are looking to buy the S&P 500, or SPY stock specifically, there should be a correction soon with which to get a better price.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.