Potential Challenges Await: What Could Derail the U.S. Stock Market's 2024 Rally?

After a strong two-month sprint that led to record highs for the Dow and the S&P 500 in December 2023, some portfolio managers and strategists are concerned that the market could experience a post-New Year's Eve hangover in January 2024. 

One of their concerns is that the January effect, instead of providing a tailwind for the market, might work in reverse as investors rush to secure their gains from the S&P 500's 24% increase in 2023. 

James St. Aubin, chief investment strategist at Sierra Investment Management, suggests that a market cooldown after a powerful advance would not be surprising. 

Here are a few potential factors that could trip up the market in January: 

U.S. stocks are already overbought: The widely followed 14-day relative strength index (RSI) on the S&P 500 indicates that U.S. stocks have been overbought for a month. Although the RSI has pulled back slightly from its highest level since 2020, it still hovers around 70, which analysts consider the threshold for being overbought. 

Sentiment has swung from extremely bearish to extremely bullish: According to the American Association of Individual Investors' sentiment survey, investor sentiment has shifted drastically from being incredibly bearish to incredibly bullish in just two months. This swing in sentiment, which is often seen as a reliable counter-indicator, has historically preceded market turns. 

The VIX is extremely low: The Cboe Volatility Index (VIX), also known as the fear gauge, is at a very low level. The VIX measures implied volatility based on traders' expectations of the S&P 500's volatility in the coming month. Some investors worry that such low volatility could be a cause for concern. 

Progress on inflation could stall: Investors are anxiously awaiting the next U.S. inflation report, which is due on January 11. If the report shows the hottest inflation reading since May, stocks might not respond as positively as they have in the past to slightly cooler core inflation readings. 

Earnings season could disappoint: Although the earnings recession among the largest U.S. companies came to an end in the third quarter of 2023, investors wonder whether companies can meet Wall Street's optimistic expectations for 2024. Analysts expect S&P 500 aggregate earnings to increase by 11.7% for the calendar year 2024, but some question whether the market has already priced in this growth. 

Other potential threats to market calm include political and geopolitical events such as Taiwan's upcoming presidential election, the U.S. federal debt-ceiling showdown, the 2024 Republican presidential primaries, and ongoing conflicts in Gaza and Ukraine.

Ultimately, the market may already be pricing in a better 2024, with anticipated rate cuts from the Federal Reserve and broad market expansion. If the Fed delivers as expected, the rush to take profits could drive stocks lower instead of propelling them to new highs. The market may have already priced in aggressive rate cuts, and unless the central bank surpasses those expectations, the main U.S. equity indexes could struggle to continue their rally.