Keep an eye on the Red Sea because events there could change everything.

The odds of a major stock market decline in the last two weeks of 2023 are small. That’s because investors who have missed the rally in stocks and bonds, which I predicted in October, are having to play catchup.

The cynics on Wall Street call this type of behavior window dressing as big funds buy stocks at the end of the year to prop up their results, impress their clients, and maximize their fees and commissions. The biggest cynics call it FOMO (Fear of Missing Out).

No matter how you describe it, it’s a fact of life on Wall Street. The upside is that, even though there are no guarantees, holding stocks in the last two weeks of the year usually works out reasonably well. So far, this year seems to be no different, although things can change rapidly.

What’s more important is what awaits in the new year. Because it’s an election year during turbulent times in the world, uncertainty is likely to increase. And uncertainty creates market volatility and frustrating market conditions.

So, although I’m not bearish, I wouldn’t be surprised to see increasing bumpiness in stocks early in the new year.

Year Four Summary

In general, based on data from the Stock Trader’s Almanac, the fourth year of the presidential cycle tends to be one where stocks rise, albeit less than they did in year three.

Average returns for the S&P 500 (SPX) average 16.3% in year three and 6.7% in year four. Compare this to the average gain for SPX since 1930 which is 6.34%. Year one is usually similar to year four, while year two is the traditionally worst one for the cycle, which is based on expectations that the Federal Reserve tends to raise interest rates in years one and two while it tends to pause in year three and ease in year four.

This cycle, the Fed has followed the script, raising rates in years two and three, while it is possible that it may ease rates in year four. If that happens, the most important thing to monitor is how the market responds.

The price chart for the cycle during the Biden presidency shows that it has followed the general expectations with years one and three delivering gains while year two showed a decline.

Note that the gains have accelerated in year three as the U.S. 30 Year Bond yield (TYX) has fallen, while inflationary pressures (CRB Index) have subsided and the U.S. Dollar’s strength has decreased. Lower interest rates, lower inflation, are positives for the economy. A lower dollar often boosts U.S. exports, which is also bullish for the economy.

The New Red Scare

As I write, the war in Ukraine continues to unfold. And while that conflict remains important, the events in the Middle East seem to be expanding. I refer the emerging situation in the Red Sea, as the New Red Scare. Attacks from Yemen based groups on ocean shipping vessels are increasing and have led to a diversion of traffic to the Cape of Good Hope in Africa. In addition, traffic through the Panama Canal has been severely curtailed due to drought conditions.

Other regional conflicts in the Middle East and elsewhere may also develop. Meanwhile, the economies in China and the European Union are struggling. There are also reports of worsening economic conditions related to severe drought and significant population shifts in Iran. The transition away from fossil fuels is slowing. Global central banks have raised interest rates to the point where risk of recessions is rising everywhere, and the deglobalization of trade persists and could be accelerated due to the emerging shipping situation.

All of which suggests that if any of these pressure points rises to a new operational level, there will be consequences. And what we learned from the pandemic is that where regular people feel the most pain is from the consequences of global events on the supply chain.

Think inflation.

Four Supply Chain Vulnerable Sectors

A great place to gauge the potential effects of supply chain dynamics is in the electric car sector. The current consensus is that sales of EV’s are slowing. On the other hand, I see more Teslas than ever, wherever I go.

Just the same, the KraneShares Electric Vehicles and Future Mobility Index ETF (KARS) offers an excellent glimpse into the supply chain for EVs. While Tesla (NSDQ: TSLA) is its largest holding, many of its other stocks are supply chain related, with the fund holding 25% basic materials related stocks such as lithium miner and processor Albemarle (NYSE: ALB).

Although, KARS has rebounded lately, the ETF’s longer term performance reflects EV investors’ are concerns about the sector’s prospects and likely its supply chain as well; while new problems related to the Red Sea and the Panama Canal are not likely to have been fully factored in. The downslope in the OBV line tells us sellers are in control.

Directly related to EV’s, and the rest of the global economy is the utility sector. While KARS is struggling, the expectation that the Federal Reserve has stopped raising rates has been a big booster of the traditionally interest sensitive utilities.

The Utilities Select Sector SPDR Fund (XLU) has rallied nicely over the last few weeks as the market priced in a pause in the rate hike cycle. The market, however, is turning cautious.

You can see that XLU is consolidating right at its 200-day moving average – the line that divides bullish and bearish trends. In addition, the ADI line (a sign of short seller activity) has just turned lower along with OBV. This signals that investors are being cautious about the prospects for electricity demand. Moreover, any supply chain disruptions and events which would reduce electricity demand may have a negative effect on utilities.

On the other hand, as investors factor in the effects of the drought in Panama and the dangers of crossing the Red Sea, the global shipping industry is suddenly a money magnet. That’s because shippers are rerouting their cargo from the Red Sea to the Cape of Good Hope in South Africa and having to work around the problems in Panama. The re-routing of cargo adds tens of thousands of miles to trips, raising shipping prices. If this persists, it could well raise inflation again.

Finally, there is the energy sector, specifically the oil stocks, as in the Energy Select SPDR Fund (NYSE: XLE), home of the major oil companies such as Exxon Mobil (NYSE: XOM). Here we see that investors are cautiously optimistic, but aren’t willing to make big commitments yet.

The ETF is above its 200-day moving average but the short sellers aren’t willing to capitulate, just yet, as the ADI line retains a downward bias. Buyers, however, are tiptoeing back in, as is evident in the bottoming out of the OBV indicator.

Keep an Eye on the Supply Chain as the Red Scare Unfolds

As 2023 ends, stocks are up, bond yields are down, and inflation has stabilized. These are all bullish indicators. But because of the geopolitical trends and the upcoming U.S. election, there are no guarantees that this benign environment can last, or won’t face temporary disruptions.

The fourth year of the presidential cycle is historically a moderately up year. Because of the current global situation – Ukraine, the Middle East, the Red Sea, the Panama Canal – and the likely bellicose tone of the U.S. presidential election, investors should expect a very choppy trading environment throughout 2024.

Thus, as many investors focus on politics, I’m preparing for the potential effects of these factors on the supply chain, their inflationary potential, and how markets respond. Important bellwethers are likely to be shares in E.V.’s, utilities, global shipping, and the oil sector.

The Fed wants to keep rates where they are for as long as it can and expects to lower them at some point, perhaps in 2024. Yet, any supply chain disruptions may trigger inflation, which will reignite the rate hike cycle.

Few in the markets are prepared for this plausible turn. So, although I’m not turning bearish, I suspect those who stay alert and act accordingly will fare better.

So once the FOMO fever wears off, we’ll see how things shape up. We may never look at the color red the same way again.

Editor’s Note: Dr. Joe Duarte just provided you with invaluable investment advice. But we’ve only scratched the surface of our team’s expertise.

For market-thumping gains with mitigated risk, I suggest you also consider the advice of our colleague Jim Pearce, chief investment strategist of Personal Finance.

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