"January Effect" is coming? These are six major events that could impact the performance of the US stock market.

In the last two months of 2023, the US stock market ended with a strong rebound, with the Dow hitting a new all-time high and the S&P 500 surging 24% in a year, just a step away from its historical peak.

However, after experiencing a crazy rally, many investors are concerned that the US stock market's gains are so huge that it may face a correction in early 2024.

James St, Chief Investment Strategist at Sierra Investment Management, said to the media:

It's not surprising to see the market cool down after a strong run.

For a long time, there has been a so-called "January effect" in the US stock market, which means that the stock market in the first month of the new year usually brings positive returns. Historical research data shows that the "January effect" has a high success rate, with only 4 failures out of 52 years from 1950 to 2002, with an accuracy rate of 92.3%.

However, some investors point out that considering factors such as technical indicators, sentiment indicators, and economic data, the "January effect" in the stock market may not necessarily continue this year. Here is some evidence:

US stocks are already overbought

Several institutions have stated that from a technical perspective, US stocks have reached overbought levels.

According to FactSet data, the 14-day relative strength index (RSI) of the S&P 500 reached 82.4 on December 19, the highest level since 2020.

The RSI index measures the speed and magnitude of stock price changes. Generally, an RSI above 70 is considered overbought, while below 30 is considered oversold.

Although the RSI index has since retreated, it is still hovering around 70, indicating overbought levels.

In addition, CICC also stated in a report released at the end of last year that speculative net short positions in US stocks have increased.

Investment bank Jefferies pointed out that investors who enter the market after the overbought point are likely to get trapped, but this point may also indicate that the stock market is starting to move towards record highs.

Sentiment has shifted from extreme bearish to extreme bullish

The weekly sentiment survey conducted by the American Association of Individual Investors (AAII) shows that in just two months, investors have shifted from extreme bearish to extreme bullish.

The AAII survey released before the Christmas holiday showed that nearly 53% of respondents expressed bullish sentiment, the highest since April 2021. This number has slightly declined this week but remains high compared to October levels.

Traditionally, this sentiment indicator is considered a reliable contrarian indicator. Whether the sentiment indicator shows extreme bearish or extreme bullish sentiment, it may indicate an upcoming market reversal.

When the S&P 500 hit its lowest point since the 2022 bear market in July and October, investor sentiment also pointed to extreme bearishness, but the market soon reversed and turned upward.

Extremely low VIX index

The Cboe Volatility Index (VIX), also known as the "fear index" among investors, measures the market's implied volatility. Based on the trading activity of options contracts linked to the index, the volatility of the S&P 500 index can be calculated for the next month.In December, the VIX index fell below 12, reaching a new low since January 2020.

Nancy Tengler, CEO and CIO of Laffer Tengler Investments, stated to the media that she is closely monitoring the VIX index. Once the VIX index starts to rise, it indicates that a "major correction" in the US stock market is imminent, and investors should consider withdrawing some chips.

Limited Decrease in January Inflation

On January 11th, the US will release CPI data for December. According to inflation forecasts from the Cleveland Fed, the MoM increase in core CPI in December is expected to exceed 0.3%. If the forecast is accurate, it will be the largest increase since May.

Moreover, even if the core inflation rate continues to decline, the stock market has already priced in expectations of interest rate cuts and may not be as enthusiastic as before.

Larry Adam, Chief Investment Officer at Raymond James, stated to the media:

"The US CPI for December may continue to decline, but the question is, can the stock market continue to rebound?"

Disappointing Earnings Season

Affected by high inflation and high interest rates, large US listed companies have faced three consecutive quarters of YoY profit decline since the fourth quarter of 2022.

Although the "profit recession" finally ended in the third quarter of 2023, the challenge for investors now is whether companies can meet Wall Street's high expectations for 2024.

Consensus expectations show that analysts expect a 11.7% increase in total earnings for S&P 500 constituents in 2024. The booming AI industry and the resilience of the US economy have increased analysts' confidence in corporate earnings.

Once overly optimistic expectations collide with weak realities, the stock market will undoubtedly be dragged down.

Geopolitical Factors

Geopolitical factors are seen by many institutional investors as the biggest black swan in the global market next year.

In 2023, the Israeli-Palestinian conflict and the Russia-Ukraine conflict continue, and the Red Sea route is still blocked. These issues may not necessarily be resolved by 2024.

At the same time, the US will have a presidential election in 2024, and the debt ceiling issue will once again become the focus of partisan disputes.

A survey by Natixis SA of 500 global institutional investors shows that respondents generally believe that geopolitical risks are the biggest threat to the global economy and market expectations in 2024.

Analysts at Pictet Asset Management also warned that geopolitical risks are unlikely to decrease, and 2024 will not be a peaceful year. They recommend that investors adopt defensive strategies.