The S&P 500 Started the Year with Terrible Breadth

Balancing Optimism with Caution

Jan 05, 2025

Market Overview

Happy New Year! We hope you had a wonderful holiday season surrounded by loved ones. Looking back, 2024 was a remarkable year for the markets, and we approach 2025 with optimism for continued opportunities. In our market outlook shared on November 17th, we noted:

"Still, we expect volatility ahead and prefer targeting longer-term opportunities to complement our existing holdings. We anticipate the index to trade near 6,000, with a 300-point range, over the next three months."

So far, this projection has held up well. The SPX straddles we sold have generated solid returns, and we successfully purchased inexpensive SPX call wings to close potential upside risk. However, the market's late December decline was a bit surprising, as we had anticipated selling pressure to emerge later in January. Our reasoning was twofold:

Investors who bought the January dips last year would receive more favorable tax treatment after holding for over a year.
The waning effect of the presidential election boost post-inauguration when reality sets in.

Our outlook remains largely unchanged: we still expect the S&P 500 to hover around 6,000 ± 300 points by mid-February. Options market data indicates increased downside protection—a logical response to recent volatility. Interestingly, there’s growing activity around the 4,000 strike, reflecting concerns about a potential 32% drop from current levels.

Our portfolio maintains a slightly short delta bias. If the market moves significantly beyond our target range, we plan to add upside or downside hedges opportunistically. Should favorable conditions reappear, selling volatility may once again become appealing, with the 6,200 strike for 3- to 6-month straddles being of particular interest to complement our existing 2025 and 2026 positions.

Much like competitive sports, trading and investing require strategic adjustments. After a strong 2024, this might be the time to adopt a more defensive stance rather than pursuing aggressive gains.

Funnymentals: An Alternative Perspective

Many of you have likely seen S&P 500 targets for 2025 based on traditional metrics like forward PE ratios and interest rates. The street consensus averages around 6,600. But instead of focusing solely on these conventional measures, we want to highlight our alternative “Funnymental” model, which links the S&P 500 to public debt.

While the national debt rises daily, the stock market does not—so adjustments are necessary. However, the correlation between these two factors remains fascinating. Based on this skeleton model, we find a year-end target range of 5,600 to 6,150 more reasonable, even accounting for the optimism surrounding AI-driven growth.

The Fed Trade Update

The Federal Reserve is likely to pause rate hikes in January. Beyond their official commentary, this pause appears to re-align with the incoming administration's priorities. Looking further ahead, we expect rate cuts unless inflation unexpectedly surges dramatically like above 6%. Otherwise, we anticipate creative justifications for easing monetary policy. Key influences include:

Potential pressure from former President Trump to lower rates and stimulate the economy.
Powell’s ambition to achieve a "perfect" soft landing and secure his legacy.
The promises of Elon Musk’s Department of Government Efficiency (DOGE), which aims to save $2 trillion. With limited options like cutting entitlements, reducing interest payments—now 13% of federal spending—becomes an attractive target.

In the bond market, our positioning remains unchanged. We continue to hold long positions in 2-year Treasuries and short positions in 10-year Treasuries, following our recent roll from December contracts. If yields rise, we may increase our 2-year holdings opportunistically.

As we enter 2025, early signs of volatility suggest it will be another dynamic year. A disciplined approach focused on risk management and seizing opportunities will be key. We believe "PAYtience" will pay off in the current environment. While we remain optimistic, we’re not rushing into aggressive buying until more favorable conditions arise.

Earnings Next Week

For the week of Jan 6 2025, notable earnings releases for companies with a market cap above $2 billion include:

2025-01-06: AM CMC 0.00%↑
2025-01-07: PM AZZ 0.00%↑
2025-01-07: AM RPM 0.00%↑ CALM 0.00%↑ AIR 0.00%↑
2025-01-08: PM JEF 0.00%↑
2025-01-08: AM ACI 0.00%↑ AYI 0.00%↑ MSM 0.00%↑ UNF 0.00%↑
2025-01-09: PM TTAN 0.00%↑ KBH 0.00%↑ PSMT 0.00%↑
2025-01-09: AM INFY 0.00%↑
2025-01-10: PM WDFC 0.00%↑
2025-01-10: AM BAC 0.00%↑ WFC 0.00%↑ STZ 0.00%↑ DAL 0.00%↑ WIT 0.00%↑

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