Why investors should be wary of New Year ‘head fakes’ that may be pointing at this asset class

“Data that comes in too hot will kill the idea of rate cuts starting as soon as March, and data that comes in too cold will kill the idea of a soft landing. It means Goldilocks must return from her Christmas trip to Aruba and appear this week,” says Michael Kramer, founder of Mott Capital Management.

Onto our call of the day from MacroTourist blogger Kevin Muir, who sees a rally in small-cap stocks as one big theme for the coming year, though investors should beware of getting in too soon.

In a post, Muir draws on a 2021 observation from Raoul Paul, co-founder and CEO of Real Vision financial media platform, who posted on Twitter now X, at the time about the perils of piling into “head fakes” or new ideas in January.

Paul noted how hedge funds and asset managers start the new year with a clean investment slate, but then two weeks later start moving into so-called consensus Wall Street year-ahead trades. And once the rest of the investment world gets in, the trend reverses or corrects, and those managers get back to flat or have to start over.

Muir says given the Fed’s pivot away from monetary tightening at the end of 2023, small-caps will end up as stock leaders this year. A bull on that asset class, he flagged his readers to buy in early November and December.

After a tough year, the Russell 2000
RUT
rallied late in 2023 as it became clearer that Fed interest rate increases, particularly hard on smaller companies, were drawing to a close.

As per this Russell 2000 chart, Muir says he did get the timing right on that bullish call:

However, Muir says he’s concerned that the rally was mainly from “hedge fund covering,” and not a solid signal that the bear market for those stocks has ended.

One reason, he notes was that the stocks blasting higher at the end of 2023 were the most heavily shorted — he offers the Goldman Sach’s most-shorted index chart here:

The chart is evidence of how hedge funds that got caught out when the Fed surprisingly guided toward interest rate cuts at the December meeting. Within a few hours of the Fed announcement, the Most-Short index had rallied 15%. But along with that, the ARKK Innovation ETF
ARKK
also shot higher, a red flag for Muir.

That short index is tightly correlated to ARKK and the Russell 2000 small-cap index, he said.

So says it’s possible the small-cap push was “just a hedge fund short-covering rally that will sag back down now that the buying has flamed out.” And based on Raoul Paul’s theory, it makes sense that hedge funds and other investors may be piling into the asset class.

Muir says he stands by his view that small-caps are cheap and deserving of gains. “However, if this small-cap rally is for real, then it can’t be led by crap. We can’t have the GS Rolling Most-Short leading the charge. We need quality small-cap stocks to rally,” he said.

So the correlation between broader small-cap indexes and the most-shorted index (also tightly correlated with ARKK) will have to break down.

“As a proxy for this index, and a hedge against my small-cap long position, I am shorting ARKK. So far, the short covering drove all these smaller capitalized stocks higher, but my bet is that an actual small-cap bull market will see much better differentiation, and that new small-cap leadership will emerge (and it won’t be ARKK),” he says.

The markets

U.S. stock index futures
ES00,
-0.64%

YM00,
-0.47%

NQ00,
-0.94%
are sliding early Tuesday as Treasury yields
BX:TMUBMUSD10Y

BX:TMUBMUSD02Y
climb. Gold
GC00,
+0.21%
is up, and oil
CL.1,
+2.34%
by 2%. The Hang Seng
HK:HSI
fell 1.5% after weak China factory activity.

Key asset performance	Last	5d	1m	YTD	1y
S&P 500	4,769.83	0.32%	3.81%	24.23%	24.23%
Nasdaq Composite	15,011.35	0.12%	4.94%	43.42%	43.42%
10 year Treasury	3.933	3.28	-24.22	5.23	18.77
Gold	2,082.50	0.87%	1.67%	0.52%	13.79%
Oil	72.78	-0.97%	-0.70%	2.03%	-9.60%
Data: MarketWatch. Treasury yields change expressed in basis points.

The buzz

In the spotlight, U.S. nonfarm payroll data for December is due Friday, with the Institute for Supply Management’s manufacturing report and minutes of the Dec. 12-13 Fed meeting both on Wednesday. Construction spending is due at 10 a.m. on Tuesday.

Read: Health of U.S. labor market looms large on markets’ radar this coming week

Iran plans to send a warship to the Red Sea after the U.S. Navy sank some Houthi militia-backed boats and that’s lifting oil prices.

Bitcoin
BTCUSD,
+4.11%
is above $45,000 for the first time since April 2022, on ETF approval hopes.

China’s BYD
002594,
-2.73%
sold 3.02 million electric vehicles in 2023, meaning it may eclipse Tesla’s
TSLA,
-1.86%
sales for a second-straight year.

Japan’s western coast was hit by several heavy earthquakes on New Year’s Day, leaving at least 30 people dead and more quakes could come. Separately, passengers miraculously escaped a Japan Airlines flight that caught fire on the runway.

Best of the web

This year, resolve to pack a ‘go bag’ to be ready for the next disaster: Here’s what to put in it

Why Suze Orman never goes out to dinner

Topless massages, cage fights and private flights: CEO mishaps of 2023

The chart

More on small-cap caution from Chris Kimble at See It Market. He points out that investors may be getting greedy as some big resistance levels approach for the Russell 2000:

Top tickers

These were the top-searched tickers on MarketWatch as of 6 a.m.:

Ticker	Security name
TSLA, -1.86%	Tesla
MARA, -16.44%	Marathon Digital Holdings
NIO, -3.82%	Nio
NVDA,	Nvidia
GME, -2.99%	GameStop
AAPL, -0.54%	Apple
AMC, -1.45%	AMC Entertainment
COIN, -6.68%	Coinbase GLobal
MULN, +1.20%	Mullen Automotive
RIOT, -12.10%	Riot Platforms

Random reads

New Year’s Eve in a Japanese cat bar.

Woman sues Hershey for $5 million over a faceless Reeses pumpkin.

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