Stocks look ready for a February rally, but chart strategists warn it could be short-lived

Published Mon, Jan 31 20223:00 PM ESTUpdated Mon, Jan 31 20224:11 PM EST

Patti Domm @in/patti-domm-9224884/@pattidomm

Investors who can't wait for January to end may find relief in a February stock market rally, but it likely won't last. "The pre-requisite for a multi-week rally is in place," said Ari Wald, technical analyst at Oppenheimer. "We're going to be watching the underlying behavior of the strength of that rally. We question whether it's going to be powerful enough to start a resumption of a longer term advance." Usually a good month for the market, January brought swift and sudden pain for investors after the nearly 27% S & P 500 gain for all of 2021. While 1.9% higher Monday, the S & P is down about 5.3% for the month, its worst since March 2020. The Nasdaq bounced 3.4% Monday in a rally driven by tech names, but it is still down about 9% for the month. Wald said the market seems set to follow the Elliott Wave theory , which suggests that markets move in waves driven by investor sentiment. In this case, there's a big sell-off in the first wave, then a narrow relief rally, which is followed by a third wave sell-off that results in capitulation. The market may now be on the brink of the second wave. "I think the first week or two [of February] could be better. On Friday, we had a decent reversal," said Scott Redler, T3, Live chief strategic officer. "We did get some less-than-feared inflation data on Friday which helped the Nasdaq. I would think if the market was going to try an oversold bounce, this is the week to do it. You have flows coming in for February." Redler said traders are now watching the January employment report, which is expected Friday morning. If the results are weak, it may add fuel to a rally. That's because investors may think the Federal Reserve will be less aggressive with interest rate hikes if the jobs market is weakening. Selling the rally Even if the rally gains steam, strategists who follow charts say the rally probably should be sold. Redler, who follows short-term technicals, said he expected 4,500 would be a level to sell the bounce, but the S & P shot past that level Monday, and he now sees resistance at 4,560. Redler said the S & P 500 chart has the potential for a "head and shoulders" formation. This is a negative signal that looks like a bump up — the head — between two lower bumps — the shoulders. "Within the next two weeks, I'd think the right shoulder builds," he noted. Short-term resistance should be 4,530 to 4,560. Wald said he expects the rally in the S & P 500 could even go further, possibly to 4,700, a point where investors should then look to reduce holdings. A first level of resistance could be the 100-day moving average at 4,567, and then the 50-day at 4,631. The S & P had fallen below its 200-day moving average, but was trading above it Monday. A close below the 200-day moving average could signal the start of a period of more lows, while regaining it is seen as positive. For the S & P, that level was at 4,436 Monday. Wald said while the bottom is not likely in, it should not be far below the 4,222 the S & P 500 reached last Monday during a selling crescendo. That day, the Dow Jones Industrial Average took a 1,000-point dive and then recovered. "We think the bulk of the magnitude was reached in that January 12% drop peak to trough," Wald said. "The damage underneath the surface should be respected. This rally is likely to lack technical strength." The selling has shown signs of exhaustion. Wald said there were 300 net new lows on the New York Stock Exchange Friday and the sentiment indicators are turning more negative. Wald said the megacap stocks, like Apple and Microsoft, have been holding up, and they could push the rally further. But the rally will not be confirmed, or more lasting, unless the most battered of high-growth and tech stocks find a bottom. The stock market sell-off was prompted in large part by the Federal Reserve's shift in stance from a dovish, easy money policy to a more hawkish one, in which it is ending asset purchases and moving to raise interest rates as soon as March . Fed triggered sell-offs Chart strategists are looking back at two other periods when the Fed's actions upended the market. Wald points to the steep declines in late 2015 and early 2016 around the Fed's first post-financial crisis rate hike in December 2015, the first hike since 2006. "There were two separate 12.5% and 14.5% declines around that hike," he said. "There was an initial sell-off in August, and then another in January." The other period was the sharp sell-off in the end of 2018 as the Fed raised the fed funds target rate for the final time in that cycle. At the time, then-President Donald Trump was critical of Fed Chair Jerome Powell and the central bank's policy. "If you want to relate this to the taper tantrum of 2018, the S & P was down 20% and the Nasdaq was down 24% in three months," said Redler. "That's when Powell pivoted." This time, the market is reacting to the Fed's unwinding of the easy policies it quickly implemented in early 2020 to save the economy and financial markets from the harsher impacts of the pandemic. The Fed's policies are credited with helping stocks rebound. Wald points out that it wasn't until the end of 2020 that the market really set up for the rally of 2021. It was late in the year when hard-hit industries, like airlines and others that are reopening-centric, joined the rebound. If there is a widening of the February rally like that, beyond megacaps, it could prolong stocks' climb and become a new leg up instead of a temporary bounce, he said. Wald said he is looking forward to a better back part of the year, and the rebound rally should end sometime before the "sell in May" period. That is a reference to the adage that stocks do more poorly between May and October than between April and November. But this year, selling in May could be rocky, since it is the second year of a presidential cycle and the year that Congress faces midterm elections. "This is the start of midterms. Equity markets have typically performed poorly looking at history," Wald said, noting the second and third quarter of the midterm year are the worst for stocks in the presidential cycle. "Then that's followed by a sweet spot in the fourth quarter of midterm years," he said, noting that continues for the first and second quarter of the next year. That is traditionally the best period for the stock market. Another seasonal factor has gone awry for markets this year. January is more often a positive month . When it is, the stock market tends to be higher for the year. However, when the first month of the year is negative, the correction often continues. This year, investors could worry about the phrase, "so goes January, so goes the year." But Sam Stovall, chief investment strategist at CFRA, said that January phenomena has not always proven to be right. Yet he did look at the market relative to how it fared after a positive Santa rally , then a down January. The Santa rally period is the final five trading days of the year and the first two of the new year. Since World War II, there have been only eight instances like this year, in which the market was higher during the Santa rally period and then negative for the first five days of January and the remainder of the month. The market ended the year higher only 13% of the time and had an average decline of 9.6%, Stovall said.

A trader works inside a booth on the floor of the New York Stock Exchange (NYSE) in New York City, January 18, 2022.

Brendan McDermid | Reuters

Investors who can't wait for January to end may find relief in a February stock market rally, but it likely won't last.