Market Commentary: When Will The The Market Top?

Believe it or not you’re about to get a very precise answer to the question when will the market top but, before the entree, a little appetizer.

As we enter year-end, the market has a lot of bullish forces driving it higher, and should continue to support the markets into the new year.

So what is the precise date for a top? And what will 2024 look like?

Key Points

• Strong structural flows should support markets through year-end and into early 2024
• By mid-January these flows are expected to subside and weakness into February is strongly expected.
• Expect bearish macro flows to dominate then until the Fed steps in with supportive monetary policy.

What Happens When Markets Go Up Into Year End?

Among the largest bullish forces is a process called recollateralization that has been well-explained by Cem Karsan as follows. Imagine you buy a $1,000,000 home and put 20% down. Further, assume that the price goes up to $2,000,000, how much has your equity gone up?

In this example, your $200,000 initial equity is now worth an astronomical $1,200,000, so while the house has doubled in value you have gained 6x.

With $1,200,000 in equity, you could theoretically buy a home worth 5x that amount since you need to put 20% down to buy a new home. And to keep things simple let’s exclude any calculations on what your income would need to be to pay the new debt. The point is simply that when your wealth goes up so much, you can invest more money into a new, bigger home, and critically keep your debt/equity ratio at the same 80/20 level it was when you bought your first home.

Now circle back to when the stock market goes up, how do institutions and big money managers act? Well, similarly as it turns out. But unlike a single homeowner buying a new home, they need to recollateralize, or invest in a basket of other stocks to keep risk in line with whatever fund rules are in place.

In turn, that results in bullish stock flows as money gets invested across a gamut of equity assets. It’s also well-known that a good chunk of these flows are invested on the first day of the year, which creates a virtuous cycle because other managers attempt to front-run the new buys that are about to be made.

The net result is bullish flows at the start of the year and bullish flows near year-end, creating a Santa Claus rally, that all stemmed from the market having gone up in the first ten months of the year.

When Will the Market Top?

If everything goes according to plan, these bullish forces will continue until close to January’s expiration in 2024. A line in the sand when the top will form is most likely around January 17, according to Cem Karsan, though he qualifies that any time between Jan 14 and end of January 2024 is a reasonable range.

Thereafter, expect weakness originating from bearish macro forces to dominate. As the bullish structural flows subside, the bearish forces should dominate. An example of these include the flows from equity markets to bond markets as some investors naturally choose to lock in fixed-rate returns in favor or taking on risk in the stock market.

According to Karsan, the bearish forces could likely lead to a 10-15% drawdown and, absent intervention from fiscal or monetary stimulus, could well be larger. The bottom line is, absent a major tail-risk event, markets should rise through to mid-January, and soon thereafter, likely in February a broader correction should begin. We’ll be watching to see if he’s right.