Night the lights went out in Georgia Night the lights went out in Georgia http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\dark-sky-electric-poles-small.jpg January 12 2021 January 12 2021

Night the lights went out in Georgia

Yet the 'January Barometer' suggests 2021 could be positive for equities.

Published January 12 2021
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Bottom line Investors who were hoping for a quiet first week of January to ease into the new year were sorely disappointed. Despite extreme volatility to start the week and extremely unsettling political developments, stocks managed to right themselves by week’s end, providing a positive full-year market signal for the so-called “early January barometer.”

What happened last week? Stocks greeted 2021 rudely last Monday by plunging nearly 3% on an intraday basis before partially recovering. Investors began to worry that the Georgia Senate polls that forecast both Republican candidates to win their runoff elections were wrong. On Tuesday, those concerns were fully justified, as Republicans snatched defeat from the jaws of victory. Incumbent Senators David Perdue and Kelly Loeffler both lost winnable seats to challengers Jon Ossoff and Raphael Warnock, respectively.

That deadlocks the Senate at 50-50, effectively handing consolidated legislative control of Washington to incoming President Joe Biden, with Vice President-elect Kamala Harris voting to break all ties. In addition, the Democratic Senate now controls committee chairs and cabinet appointments, and they get to set the floor agenda.

Wednesday was one of the most shameful days in U.S. history. In an appalling act of lawlessness, a violent band of armed protestors stormed Capitol Hill as Congress was conducting its ceremonial duty of counting the electoral votes from the contentious presidential election. Vice President Pence and members of Congress sheltered in secure bunkers as Capitol police attempted to regain control of the insurrectionists' siege.

Stocks rally hard Despite last week’s mayhem, stocks surged from Monday’s trough, as the S&P 500 rose more than 4% to set a record high on Friday. How is it possible that despite the week’s shocking developments and the imposition of a legislative Blue Wave in Washington, stocks responded positively?

Recall that last September and October, the S&P dropped about 10% when it appeared Democrats were going to run the table on Nov. 3. But equities then rebounded 16% from Halloween to New Year’s Eve, when it appeared that voters had split their ballots to deliver divided government, which would have kept fiscal policy legislation in the middle of the political spectrum.

Leap of faith In our view, investors were willing to look through last week’s disgraceful developments to Biden’s inauguration on Jan. 20, which (at a minimum) will lower the tweet volume and the chaos in the White House. One possible legislative silver lining to a Blue Wave is a Congressional honeymoon period with Biden, likely resulting in generous fiscal policy stimulus and infrastructure spending, creating a near-term sugar high for economic activity. Investors, at least for now, also appear to be ignoring the potential risks of higher taxes and tighter regulations.

Early January Barometer suggests 2021 could be good Historically, as the first five trading days of January go, so goes the full year. Since 1950, Jeffrey and Yale Hirsch at the Stock Trader’s Almanac report that 69% of the time (49 out of 71 observations), the direction of the year—up or down—is the same as that of the first five trading days of January. But when the first five trading days of the new year are collectively positive—as they are again this year—the stock market finishes the year in positive territory 83% of the time (38 out of 46 instances). This is not a random event, in our view, as investors typically make their annual retirement and college-savings contributions and their changes in asset allocation early in the New Year, reflecting their bullishness or bearishness.

Positive start to 2021 Over the first five trading days of calendar 2021, the S&P enjoyed a strong price-only gain of 1.83%, starting from 3,756 on Dec. 31, 2020 and closing at a record 3,824 on Jan. 8, 2021. By including dividends, the total return over this period improves slightly to a gain of 1.87%. Over the past 71 years, according to the Stock Trader’s Almanac, in each year’s first week the S&P has posted a median gain of 0.70% and an average gain of 0.30% (within a wide range of 6.2% to negative 6%).

Strong full-year performance on tap? This year’s strong first-week return of 1.83% is nearly three times the median gain and more than six times the average gain. Looking at the 71-year history of the Early January Barometer (excluding this year), whenever the first week’s returns were 1.8% or higher (which occurred 20 times), the full-year return averaged 17.2%, with only one negative year (positive returns 95% of the time). That would translate into a target price of 4,400 for the S&P in 2021, slightly below Federated Hermes’ full-year target of 4,500.

Longer-term fundamentals solid We maintain our constructive view on stocks this year, as we accelerate the Covid-19 vaccine rollout to achieve an expected herd immunity by midyear, a zero-bound Federal Reserve driving the TINA trade, easy year-over-year comparisons and the aforementioned Congressional honeymoon period for the incoming Biden administration. As a result, we are sticking with our 5% overweight in stocks and 6% underweight in bonds. We remain overweight domestic large-cap value, domestic small cap and international stocks, and are neutral domestic large-cap growth, such as technology.

Constitutional crisis? True, longer-term fundamentals for calendar 2021 are very strong. But in the wake of last week’s shocking developments in Georgia and Washington, we could be on the verge of a potential constitutional crisis in President Trump’s last days in office. It’s unlikely that Trump will voluntarily step down from office, allowing Pence to finish his first term before Biden takes over. But might the remaining members of Trump’s Cabinet who have not yet resigned invoke the 25th amendment to force his removal from office? Congress also is deliberating bringing impeachment charges against Trump for a second time, which would be a record for the presidency, but they probably don’t have enough time to execute on this plan before the inauguration. While these events could spark a temporary 5-10% air pocket, we would use any near-term weakness to add to equities.

More to come We’ll return with January Barometer, Part II, in February, after the S&P has generated investment returns for the entire month of January, to see what potential full-year market implications we can draw and to identify what the top-performing industry sectors may be for the full year.

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Tags Markets/Economy . Equity .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

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