Why March could ‘make or break’ stock-market sentiment with 2023 rally at crossroads

© MarketWatch photo illustration/iStockphoto


Load Error

An early 2023 stock-market rally suffered a setback last month, leaving investors to wrestle with whether to bail out or build up positions as March gets under way.

The question is perhaps more urgent after a brutal performance for U.S. stocks last year, which saw sharp, but short-lived bear-market rallies give way to fresh rounds of selling, said Nicholas Colas, co-founder of DataTrek Research, in a Wednesday note.

“Put another way, after a very difficult 2022 we don’t want to take it for granted that stocks and bonds can hold their YTD (year-to-date) gains into the end of Q1. If last year taught us anything, it is that harvest periods can be short and it’s better to bring in whatever we have rather than wait too long and see the crops fail,” he wrote.

After an impressive January surge, the S&P 500 fell 2.6% in February, trimming its year-to-date gain to 3.4% as of Tuesday’s close. The Dow Jones Industrial Average dropped 4.2% last month, leaving it down 1.5% on the year, while the Nasdaq Composite’s 1.1% February decline left with a year-to-date gain of 9.5%.

The bottom line, Colas said, is that the “January effect,” a bounce after December tax-loss selling, was strong but didn’t see February follow through. “March could make or break investor sentiment.”

Analysts and investors largely blamed the February setback on a significant shift in expectations around how high the Federal Reserve will push up its key interest rate after a series of hotter-than-expected labor market and inflation readings for January. Money-market participants came into the month doubting the Fed’s resolve to lift the fed-funds rate above 5%, as the central bank has projected. They also had priced in rate cuts by year-end.

As of the end of the month, fed-funds futures reflected expectations for a peak in the 5.25% to 5.5% range and largely factored out prospects for cuts.

See: The 2023 stock market rally looks wobbly. What’s next as investors prepare for longer inflation fight.

But seasonal factors were also unfavorable for stocks, particularly in the second half of February, analysts said. Seasonals turn more in favor of stocks in March.

“Just as the S&P 500’s price action again proved frustrating in February, the market’s movements in March have typically been more encouraging, rising in price 64% of the time since 1945 and recording not only the fifth-highest average gain but also the fifth-lowest volatility,” Sam Stovall, chief investment strategist at CFRA, told MarketWatch in an email.

He noted that results were even better during the third year of the presidential cycle, with the S&P 500 posting gains 74% of the time.

“Despite investors’ concerns that this month’s upcoming inflation, employment, and retail sales reports may again come in hotter than expected, we think much of this anxiousness may already be reflected in share prices,” he said.

It’s also important to note that the February pullback came not only after a strong start to the year, but also after a strong run off the October lows, noted Ryan Detrick, chief market strategist at Carson Group in a Tuesday blog post.

“After the nearly 17% rally off the October lows into mid-February, some type of hangover or indigestion made sense. The good news is that we don’t expect this weakness to last much longer,” he wrote. “March and April are historically two of the strongest months of the year, but they have done even better in pre-election years.”

Colas said that investors are wrestling with a U.S. and global economy that appears to be reaccelerating, causing inflation to remain elevated amid little evidence that last year’s interest rate hikes are causing a slowdown just yet.

That leaves investors with three good reasons to take profits and three equally good reasons to hold tight, he said.

Reasons to cut and run include the March 22 Fed meeting, which is almost certain to see policy makers up their forecast for the where the fed-funds rate will end 2023. While that shouldn’t come as a surprise, the market last year was plagued by down days immediately before or after Fed meetings, Colas noted.

The other reasons include what’s likely to be another month of strong economic data as February readings roll in and a continued decline in corporal profit expectations.

Reasons to hang on include the possibility that February economic data will likely be at least somewhat weaker than the January readings, which could temper fears of a more hawkish Fed and cap rising interest-rate expectations.

Aggressive cuts to first-quarter corporate earnings estimates mean there might be some upside once companies begin reporting results in early April, which could help keep stocks stable in March or even provide a bit of a tailwind, he said.

Third, the Cboe Volatility Index a measure of S&P 500 expected volatility over the coming 30 days, closed Tuesday at 21, just above its long-run average of 20, showing markets aren’t as complacent as they were in early February at the year-to-date highs when it was just below 18, Colas noted.

DataTrek’s bias is toward caution, “but we will freely admit that one can make a good argument either way,” he wrote. “In the end, we are still concerned that current U.S. equity valuations leave little room for error or uncertainty.”

Continue Reading