Relief for Weary Stock Market Investors After a Tumultuous Week

Investors in the stock market who are hoping for a period of calm after a tumultuous 2022 can take comfort in the fact that history and options traders are on their side.
The recent slowdown in inflation has led to speculation that the Federal Reserve is close to finishing its interest-rate hikes. This has caused equity-derivative traders to anticipate a break from the market volatility that was experienced in the previous year. The volatility curve, which illustrates the expected magnitude of price fluctuations in the upcoming months, is lower than it was a year ago at every point.

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The optimism of the past two weeks appears to be justified when looking at historical data. Since 1950, there have only been two consecutive years of stock market decline, which occurred during the recession of the early 1970s and after the dot-com bubble burst at the beginning of the 21st century. This downturn lasted for three years. Most Wall Street strategists do not anticipate a similar situation in 2023.

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Ryan Detrick, chief market strategist at Carson Group, believes that the negative news from last year has already been factored into the markets. He is optimistic that the US can avoid a recession, which would be a major boost for stocks. Detrick also noted that inflation is the key to the entire situation.
It is important to note that investors should not anticipate a completely tranquil journey from this point forward. In fact, the month of January following a double-digit yearly decline has typically been a difficult period for the S&P 500 Index.

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The S&P 500 experienced a 2.7% increase last week, bringing its total growth for the year to more than 4%. On Thursday, the Labor Department reported that the consumer price index had decreased from the month prior and had its lowest annual increase since October 2021. This data was interpreted as giving the Federal Reserve the opportunity to reduce the rate of rate hikes at the February meeting.

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Equity bulls have been cheered by the recent stock-market gains, which come after the S&P 500 experienced a 19% drop in 2022, the most significant decline since the 2008 financial crisis. Historically, such downturns have been followed by a rebound: According to data from Carson Group since 1950, the S&P 500 has typically risen by an average of 15% in the following 12 months.

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Emmanuel Cau, a strategist at Barclays Plc., suggested that markets may have valid reasons to be optimistic about inflation and not take too seriously the hawkish statements from central banks.
Despite the recent market rally, stock investors remain concerned, as evidenced by the $2.6 billion that was withdrawn from US equity funds in the week ending Jan. 11, according to a report from Citigroup Inc. and EPFR Global.

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The Federal Reserve may not meet the market's expectations. Officials have suggested that traders are incorrect in their predictions of interest rate cuts in the near future. Additionally, the release of corporate earnings reports could bring unforeseen risks.
Those who are doubtful that the gains made in January will be maintained can look to past events for evidence. Since the start of the 21st century, there have been four years in which the markets experienced double-digit drops. Out of those four, stocks have dropped in the first month of the following year three times.
The stock market's gains in January may not last long, as volatility is likely to return soon.

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At this time, traders are not expecting any major surprises. The two main economic reports for the month, the employment figures and the consumer-price index, have already been released and demonstrate that growth is still steady and inflation is decreasing.
The Cboe VIX Index, which is usually inversely correlated to the S&P 500, ended the week at around 18, the lowest it has been since the start of the year.
In recent weeks, institutional investors have been reducing their short equity positions, and the net-long position was increased to its highest level since May 2022, according to an analysis of CFTC data by Ned Davis Research.

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Ed Clissold, chief US strategist at Ned Davis Research, believes that if a recession only lasts two quarters, markets should be expecting a recovery by the end of the year. He also believes that if inflation data remains favorable and earnings are good, hedge funds will likely cover their short positions, which could be a catalyst for the rally to continue.