After a tumultuous year in the markets in 2022, when the Federal Reserve underwent an unprecedented interest rate hike cycle with an 18-fold increase in the federal funds rate over nine months and a war between Russia and Ukraine broke out, the S&P 500 index rebounded in January with a 6.2 percent rally. Interest rates on the 10-year Treasury Note fell from 3.88 percent at the end of 2022 to 3.52 percent on signs that inflation is decelerating.
In our last piece we highlighted the fact that despite the massive interest rate hikes in the second half of 2022, the S&P 500 index registered a 1.4 percent increase. While that was not something to cheer about, it was an indication that perhaps a good portion of the selling was behind us as stocks tend to bottom on bad news.
Another reason for the January rally is likely due to positioning. For example, net speculative S&P 500 futures contracts have been negative (net short positions) for 32 consecutive weeks, indicating a persistent bet that the S&P 500 index would decline. What’s more, a prominent Wall Street firm suggested that there was no reason for investors to take on risk, which is quite extreme. In addition, the fourth quarter saw equity fund allocations underweight by the most since 2005.
As a result, investor sentiment had gotten so negative, a small bit of good news had the potential to spark a rally.