Stock market investors expecting smoother sailing have history on their side

Stock market investors hoping for a break after a brutally volatile 2022 have history — and options traders — on their side.

With sluggish inflation supporting speculation that the Federal Reserve is nearing the end of its interest rate hikes, equity derivatives traders are anticipating an exit from the turmoil that continued to race through the markets last year. This has resulted in the so-called volatility curve – a chart showing expectations of the severity of price swings in the coming months – lower at every point than it was a year ago.

Other historical data points also suggest that the optimism of the past two weeks was not misplaced. Among them: There have only been two consecutive annual declines in the stock market since 1950, during the recession of the early 1970s and after the burst of the Internet bubble at the beginning of this century, which lasted three years. Nothing along these lines is expected in 2023, at least among base case scenarios from most Wall Street strategists.

said Ryan Detrick, chief market strategist Carson Group. He believes the US can avoid a recession, which will be a “major positive catalyst” for stocks. We see steps in the right direction with inflation. This is the key to the whole puzzle.”

Of course, investors shouldn’t expect completely smooth sailing from here. In fact, January after the annual double-digit decline has historically been a rough month for the S&P 500.

However, the S&P 500 rose 2.7% last week, up more than 4% for the year. The Ministry of Labor said on Thursday The consumer price index fell in December of the previous month and recorded the smallest annual increase since October 2021. The data was widely seen as giving Fed officials room to further reduce the pace of interest rate hikes at the February meeting.

These stock market gains are welcome news for stock bulls after the S&P 500 posted a loss of more than 19% in 2022, the worst hit since the 2008 financial crisis. The good news is that such low years are usually followed by a rebound: The S&P 500 of them rose an average of 15% in the next 12 months, according to data since 1950 compiled by the Carson Group.

said Emmanuel Cao, strategic analyst at Barclays plc.

However, there are still reasons for continued concern among equity investors, who withdrew $2.6 billion from US equity funds in the week to Jan. 11, according to Citigroup Inc. Note citing global EPFR data.

It is possible that the Fed will eventually defy market expectations. For example, officials point out that traders are wrong to expect rate cuts later this year. The latest round of corporate earnings reports has just started issuing and is taking its own risks.

The continuation of skeptical gains in January could also signal a precedent of their own. On the four occasions that markets have posted double-digit declines in a year since the beginning of this century, stocks have fallen three times in the first month of the following year.

But for now, traders are at least not expecting any major shocks. The two main economic reports for the month – Employment figures and the Consumer Price Index – have already been released and they show that growth continues to climb and inflation is moderating.

The Cboe VIX — a measure of expected price volatility in the S&P 500 that typically moves in the opposite direction of the index — ended last week at around 18, the lowest level since last January.

Institutional investors have been covering their short bets on the stock for the past several weeks, and earlier this month boosted their net long position to the highest level since May 2022, according to a Ned Davis Research analysis of CFTC data.

“If there is a recession where it lasts about two quarters, by the time we get to the second half of the year, the markets should have started to recover,” said Ed Clissold, chief US strategist at Ned Davis Research. “If favorable inflation data persists and if earnings are very good, you can demonstrate that hedge funds will continue to hedge their short positions, which would be good fuel for a continued rally.”

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