A Technical Look Ahead To 2023

Investors will be happy that next week is the final one of 2022. The outgoing year proved to be a trying year for both professional and retail investors. As of this writing on December 21st, the S&P 500 is down over 18%, the NASDAQNDAQ
over 31% and the small capitalization index Russell 2000 over 20%. Many of the underlying statistics below the simple averages are even worse. For example, through the first nine months of the year, the Russell 2000 had declined on 54% of its trading days; only 1984 at 55% was worse. In addition, through the first nine months, stocks rose or declined 1% or more, 63% of trading days, tying 2008 for the most volatile year since 1979. Finally, year to date, 25% of S&P 500 stocks, 54% of NASDAQ stocks and 44% of Russell 2000 stocks are down 30% or more.

From an O’Neil Methodology perspective, bull markets start with a successful Follow Thru Day (FTD), defined as an increase in the market averages of 1.7% or more on higher volume than the preceding day. However, in a bear market, we expect there to be 4-5 false FTDs that undercut their previous established low before the market finally bottoms. As shown on the tables below, this bear market has had a typical number of failed FTDs and the pump-fake bear rallies have been roughly in-line with history, on average.

Bear Markets Comparison

The History of Failed Follow Through Days, 1970 – 2020

2022’s Failed Follow Through Days (FFTD)

Usually, painful years like 2022 are followed by rebounds in the major averages. While O’Neil Global Advisors is optimistic that this may occur, the prior bear markets metrics give us pause. If the lows from October hold, this bear market would be one of the shorter bear markets on record at 282 days versus the historical median of the last 50 years of 525 days as shown on the table above and displayed in the chart below. This graph is a comparison of the Dow Jones Industrial Average that goes back a bit further, showing how the current bear market stacks up against the prior nine since 1950. If you’re bullish and think the market bottomed in October, the 2022 market shows similarities to the shorter bear markets in 1961 or 1966. Alternatively, one could identify that 2022 is very similar to where bear markets in 1973 and 2000 were at the same length, which would argue for a more protracted bear market.

The damage by sector has been remarkably widespread this year with only Energy posting positive returns year to date, though performance has been waning recently. Some of the strongest and weakest themes are detailed below.

Quarter by Quarter vs. 2nd Year Presidential Cycle History

Ironically, 2022 has generally stayed true to history by being a year of weak overall stock market performance, and quarter-by-quarter, tending to follow the direction of the presidential cycle average. Notably, returns have been very exaggerated in both directions.

If the pattern continues into the third year of the presidential cycle in 2023, investors should have a much more rewarding year as the third year of the cycle has the best average of the four years with the S&P 500 averaging a gain of +16% and the NASDAQ +28%.

The gains tend to be heavily weighted towards the first half of the year, and in fact the S&P 500 has never been negative in the first half of the third year of the presidential cycle since 1970.

S&P 500 Index Performance in 3^rd Year of Presidential Cycles, 1970 – 2019

O’Neil Global Advisors feels this could still fit despite the negative setup of the major stock indices currently. Here are several possibilities:

1) An average first half gain would lead to a break above the 4,325 level or the August peak of the S&P 500. This would mark the first major “higher high” and a likely end to the current bear market.

2) The second possibility is below average but still positive gains. The S&P 500 could gain up to 13% from current levels and still be below August peak. This would create a debate of whether the market is still in an ongoing bear market or new bull one.

3) Finally, if first half returns are negative, which would be the first occurrence in the last 14 examples, and the market does not take out its August highs, then the ongoing bear market would continue.

S&P 500 Index, July 2021 – December 2022

For the Nasdaq, the current setup is much more negative. The index is testing an up-trending line that it has held for the past six years except for a brief dip in March 2020. Its Relative Strength (RS) line versus the S&P 500 is now at its lowest level since March 2020 as its heavy Technology weighting has turned into an extremely negative factor.

Nasdaq Composite, March 2016 – December 2022

In the bull market scenario, O’Neil Global Advisors believes growth stocks are likely to lead even if it is only a short-term oversold bounce. However, longer term, value stocks remain far behind growth in terms of relative performance over the last 20 years and may be better positioned for continuing relative outperformance.

Growth ETF vs. Value ETF (Growth outperforms when above zero), October 2001 – December 2022

After a several years of marked underperformance, small cap stocks might be set to outperform large. This has occurred several times after major bear markets. Presently, large growth stocks, as represented by the Nasdaq 100, have much better trailing 5-year sales and EPS growth than the overall S&P 500 and the Russell 2000. However, current and forward growth estimates are roughly in-line. Yet, large capitalization stocks are much more expensive on a P/E basis as seen in the table below. Current Relative Strength leadership, represented by stocks with a 90 or greater RS score in the O’Neil Methodology, is a mixture of both large and small stocks and has profile of growth acceleration rather than deceleration. Also, forward estimates for these leadership stocks are roughly in-line with 5-yr. history, and trading at median of just 15x 2023 earnings. We suspect this may represent a shift towards smaller stocks and growth stocks.

Are Large Cap Stocks Overvalued?

*AAPL, MSFT, AMZN, GOOGL, TSLA, NVDA, META, PEP, AVGO, ASML

**skewed by % of companies without positive earnings, much less so for S&P 600

***509 stocks above $1B market cap

As in 2000-2002, a clue of possible longer-term outperformance could be the Relative Strength of small caps throughout the bear market. This time around, the RS gains have not been as pronounced, although the Russell 2000’s RS line versus the S&P 500 is higher since the start of 2022.

Russell 2000 iShares ETF, 1992 – 2022

If this is the emerging new leadership of the market, it would mark a change similar to what occurred after the 2000-02 bear market. In that instance, leadership came from either large value or small stocks, with very few leaders from large growth. That said, from a broad perspective, we think the following themes could be fertile areas for finding some of the next market leadership.

· Higher interest rates for longer, favors insurance providers.

· Consumer trading down as economy weakens.

· Trucks and automobiles becoming computers on wheels.

· AI-increased efficiency and cost reduction as next exponential Tech change.

· Rising mental health and wellness spending.

· Clean energy buildout.

· Electric vehicle adoption.

· Infrastructure repair/upgrade.

To conclude, while 2022 was the year of the bear, history suggests that 2023 could be better for investors. Returns following major down years plus the presidential cycle and the possibility of new market leadership make us optimistic. We will be sure to update these trends to our readers as the new year progresses. Finally, we would like to wish all of the Forbes community Happy Holidays.