We kicked off the new year of 2024 with an overheated stock market, excessively bullish breadth indicators, and euphoric sentiment levels. While the first week in January felt like a “wake-up call” pullback for awestruck bulls, this last week saw the S&P 500 push right back up to all-time highs.
On that note, leading growth names like META are making new all-time highs. But will the S&P 500 and Nasdaq 100 follow suit, or is this the last gasp higher in a double top pattern for the major market averages?
Today, we’re going to revisit a concept called “probabilistic analysis”, where we lay out four different potential scenarios for the S&P 500. There are three things I hope you take away from this exercise.
- It’s important to have a thesis as to what you think will come next for stocks. This should be based on a meaningful combination of four key pillars: fundamental, technical, macroeconomic, and behavioral. And your portfolio should be positioned to reflect what you see as the most likely outcome.
- It’s also important to consider alternative scenarios. What if the market is way more bearish than you’d expect? What if some five-standard-deviation event pops up, and stocks suddenly shoot higher? The best way to break out of your predetermined biases is to actively consider alternative points of view. This exercise forces you to do just that.
- It’s incredibly important to think about how you would adapt to one of those alternate scenarios. How would your portfolio perform in a risk-off environment in the coming months? Are you prepared for a sudden spike in risk assets, and at what point would you need to change your positions to match this new reality? By thinking through these potential outcomes now, you’ll be much better equipped to deal with what actually plays out.
I have found that the most successful investors don’t know all the answers, but they ask the best questions. So let’s broaden our horizons a bit, and consider four potential future paths for the S&P 500 over the next six to eight weeks. But first, we’ll highlight some key levels to watch in the coming weeks.
After a strong rally off the October 2023 low, the SPX has now settled into a short-term range between 4700 and 4800. Any time a market settles into a range like this, we know two things. First, a breakout is likely happening fairly soon. Second, whichever way the price breaks, there will most likely be some further move in that same direction.
If the S&P pushes out of this range to the upside, then we will have broken to a new all-time high, and that “big round number” of 5000 will finally be within our grasp. What’s striking about a bullish scenario here is that the S&P has followed the seasonal patterns incredibly well over the last 18 months. Further strength here would absolutely go against normal seasonal weakness in Q1 of an election year.
Author’s note: I did indeed promise to play the trumpet on my show, The Final Bar, if and when the S&P 500 breaks above 5000. I will uphold that promise — and have already pulled out the horn to polish it up a bit.
If the market turns lower in the coming weeks, then I’d be watching two key levels below short-term support around 4700. 4600 was the market peak in July 2023, and I would not be surprised if that market follows the technical analysis concept called “polarity”, where previous resistance becomes support. Below that, we have an important price gap around 4450. To me, this represents the “line in the sand” for bulls, and if the S&P 500 would fail to hold that level (see the Super Bearish scenario below), then we may be in for plenty of pain into Q2.
Let’s get to the four potential scenarios, and remember, the point of this exercise is threefold:
- Consider all four potential future paths for the index, think about what would cause each scenario to unfold in terms of the macro drivers, and review what signals/patterns/indicators would confirm the scenario.
- Decide which scenario you feel is most likely, and why you think that’s the case. Don’t forget to drop me a comment and let me know your vote!
- Think about each of the four scenarios would impact your current portfolio. How would you manage risk in each case? How and when would you take action to adapt to this new reality?
Let’s start with the most optimistic scenario, involving new all-time highs as soon as next week.
Scenario #1: The Very Bullish Scenario
In this first potential outcome, the pullback in early January was just a brief reset. Buying power that we observed this week continues, leading names like META and NVDA push onward and ever upward, and it’s risk-on across the board.
The Fed meeting later this month, in this scenario, probably leaves investors with a dovish sense of comfort, as the goldilocks scenario championed by the Fed is priced in with a broad and powerful advance well above the 5000 level.
Scenario #2: The Mildly Bullish Scenario
Perhaps a break to new all-time highs is a little much for investors to digest, given the sky-high valuations we’re already experiencing and the excessive bullish breadth and sentiment readings we’ve observed.
The second scenario, then, means that any break above 4800 is short-lived, the uptrend fails to follow through as momentum wanes, and the SPX ends February between 4600 and 4800. This could also mean that the equity markets experience more of a time correction than a price correction, not losing much ground but retrenching in the current range.
Scenario #3: The Mildly Bearish Scenario
The bearish scenarios involve a push below that 4600 level we mentioned earlier, and the third scenario would mean we don’t lose much more than that. This would be more of a price correction than scenario #2, but the SPX would importantly remain above that price gap around 4450.
It’s worth noting that the normal seasonal playbook for an election year suggests weakness through March, with a likely market low in March providing a launching pad into a strong Q2. Scenario #3 would mean we follow that playbook pretty closely.
Scenario #4: The Super Bearish Scenario
Here’s where things get really interesting. The last scenario is the “doomsday scenario,” meaning the market takes on a big-time change of character. Breadth conditions begin to turn down quickly, and the VIX spikes way above 20 as anxiety spreads among investors.
Perhaps the Fed meeting and press conference end up focusing more on persistent inflationary pressures. Maybe this earnings season ends up being way more negative than investors expect. The US Dollar could push higher and resume its former role as a “wrecking ball for risk assets.” By late February, we’re discussing a retest of the October 2022 low around 4100.
Have you decided which of these four potential scenarios is most likely based on your own analysis? Head over to my YouTube channel and drop a comment with your vote and why you see that as the most likely outcome.
Also, we did a similar analysis on the S&P 500 back in September 2023. The “mildly bearish” scenario ended up matching the market action pretty closely. Which scenario did you vote for?
Only by expanding our thinking through probabilistic analysis can we be best prepared for whatever the future may hold!
P.S. Ready to upgrade your investment process? Check out my free behavioral investing course!
David Keller, CMT
Chief Market Strategist
Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.
The author does not have a position in mentioned securities at the time of publication. Any opinions expressed herein are solely those of the author and do not in any way represent the views or opinions of any other person or entity.