2017 Forecast: Market Celebrates Washington Sea Change Ride Rally Into Q2.
By: Jeffrey Hirsch & Christopher Mistal
December 22, 2016
Publication Note: Today’s Almanac Investor Email Alert for Thursday, December 22nd will be our last regularly scheduled Alert of 2016. Our next email will be on January 3, 2017. However, if market conditions warrant an interim update, one will be sent. Happy Holidays and Happy New Year!
And a Happy 50th Anniversary to you all! It is with great joy that we commemorate the 50th year of the Stock Trader’s Almanac. It will be 51 years in February that our iconic thinking founding father Yale Hirsch incorporated the Hirsch Organization to fulfill his vision and embarked on this steadfast and judicious journey of putting market history seasonality, cycles, patterns and trend following on the Wall Street map. 
You see and hear it everywhere in financial media. Phrases like “Santa Claus Rally,” “January Effect,” “Election Cycle,” and “Market Seasonality” have become ingrained in the vernacular of The Street. Seasonal trend functions are now embedded in charting software. Many market observers, investors and traders still are dubious of technical analysis, charting, seasonality, cycles, patterns and trends. Yet shrewd professional money managers continue to rely on these market patterns and tendencies to enhance timing, executions and returns.
We are always reassessing and cross-checking the patterns, cycles and tendencies we track and remain on the lookout for new trends, shifts, changes and the demise of existing doctrine. This is why we use all market analytical tools at our disposal, summarized below in our “Market at a Glance.” 
We know you have probably heard all about the upcoming seasonal, cyclical and Trump-related-election and other patterns, but let’s take a moment to review what’s coming up on the calendar in the near future and some of the trends we believe can impact the market in 2017.
2016 Forecast Recap
Last year at this time we projected, “If the Fed is right and the energy and commodities price decline proves transitory and prices stabilize, we expect average election year gains in the mid-single digits. If the Fed is wrong and oil and commodities suffer further declines and the junk bond scenario unravels we may begin a mild bear market next year.
Then at the end of January after a down January Indicator Trifecta (Down Santa Claus Rally, Down 1st 5 Days & Down January Barometer) we updated our forecast with, “Despite the pile of negative indicators, and as long as all three major indices do not meaningfully violate their respective October 2014 lows, the scenario of transitory effects remains in play and mid-single-digit full-year 2016 is still the most likely outcome.
On October 27 with the market up about 4% year-to-date across the board in our November Outlook we said it was time to “Let the Good Times Roll!” And that: “The market is likely to continue to waffle until after the election as the country and the world is a little on edge with this year’s unique circumstances. But after that we expect an upside move in November and through the Best Six Months and the first 100 days of the new President with some weakness in the first half of December and a January/February profit-taking break…
Finally on November 15 in our Super Boom Update: “We now believe that the part of this forecast that has called for a final tactical bear of 20-30% sometime in 2017-2018 may be averted. The shock and awe outcome of the recent U.S. presidential election may be an indication of a political paradigm shift and a big change in direction that could spark the next super boom. Sure the market has nearly tripled since the 2009 low, but we think the next big move is around the corner. Back in 1983 when folks started to realize the last boom was underway the market had already more than doubled. Have a look at the comparison below of the market from 1973-1986 versus today’s market since 2007. We appear to be on a similar path.
Where We Are We at Now
So the market meandered along through most of 2016 as we expected in the mid-single digit gain range until it amazed us all by rallying smartly on the heels of the surprise Trump victory. But if you think about it the best cast scenarios for Trumps agenda could mean a sea change in Washington and economic growth in this country and that’s what the market is rallying on and will continue to rally on until if and when the Trump Administration stumbles significantly. 
That’s really what our forecast is about this year: If Trump succeeds, the market booms, if he fails, the market lags. So where are we at now? Looks like tax-loss selling ran into this week, but seems to be abating now. Tomorrow, the last trading day before Christmas, has been up 7 of the last 9 years on the Dow, NASDAQ and Russell 2000 with more “bullish” days early next week and quieter trade the end of next week. 
The Santa Claus Rally also officially commences tomorrow and runs through the second trading day of 2017. This short 7-trading-day rally is usually good for modest gains of 1.4% on the S&P, but is most significant when there is a decline during the period, which suggests poor market health. This is taken into consideration with our two other early year indicators, the First Five Days Early Warning and the full month January Barometer. 
After the January 20 Trump Inauguration and the full month market performance we will have an updated read on our market outlook. For now holiday cheer, bullish seasonality and the Trump momentum should keep stocks in an upward bias. Technically, the market is consolidating the recent gains and struggling to bust through the big psychological round number Dow 20,000 level, turning 20K into a bit of a resistance level. We will likely breakthrough by yearend or early in January.
Fundamentals are mixed though improving, though valuations are getting extended from the run up since the election.  Monetary policy is still historically accommodative, despite the latest hike and while this could put a crimp on valuations, rate normalization is a good thing. Accelerating growth and economic outlook stimulated by solid and sound fiscal policy could counter any interest rate pressures.
Pulse of the Market
On Tuesday, December 20, 2016, DJIA closed just 25.38 points below 20,000 (1). This nice big round number makes great headlines and could act as resistance as some profit taking is likely around this mentally significant level. Technically, 20,000 is not that significant beyond the psychological reasons. Will it prove to be troublesome like 1,000, throughout much of the 1970’s, or 10,000 more recently or will 20,000 simply breeze by like 5,000 and never be seen again. It is far too early to say.
Both the faster and slower moving MACD indicators applied to DJIA have remained positive throughout much of the current rally. The faster moving 8-17-9 indicator (2) did briefly turn negative on the last day of November and for the first four days of December. It was then positive up until Tuesday December 20. Both indicators could turn negative if the rally does not resume soon.
Dow Jones Industrials & MACD Chart
As of last Friday, DJIA has advanced in eight of the last nine weeks and six in a row (3). Of the 1705 DJIA points gained during the past nine weeks, 610 came on Mondays (4). Strength on Mondays is usually a positive sign as it would suggest that traders are expecting further gains during the remainder of the week. This has been the case with DJIA.
S&P 500 and NASDAQ, or more specifically tech, has been lagging at various times during the current rally. Compared to DJIA’s six week winning streak S&P 500 (5) and NASDAQ (6) have each had two losing weeks. Some of this laggard performance could be attributed to a rotation out of what was working under the current administration to what might work under the next administration. In the end, tech will need to participate for the rally to continue.
NYSE Weekly Advancers and Decliners (7) have been behaving as expected. Weekly advancers were robust two weeks ago when all three major indices advanced and weekly decliners picked up last week when S&P 500 and NASDAQ modestly declined.
NYSE Weekly New Highs (8) had been steadily advancing since the second week of November until last week, but New Weekly Lows remain volatile. Some of the new lows could be the result of tax-loss selling while some could be the result of previously mentioned rotation from what was working to what might work. A consistent and steady increase in new highs accompanied by a steady decrease in the number of new lows is what we would prefer to see.
Weekly CBOE Put/Call fell to 0.53 two weeks ago (9). Recently readings at this level have occurred around interim tops. This is a cause for some concern in the near-term. Bullish sentiment is near frothy levels which could mean there is a limited amount of cash available that could be deployed in stocks to fuel the rally higher in the short term.
Click for larger graphic…
Pulse of the Market Table
2017 Forecast
So, based on everything we have looked at, including the tentative geopolitical landscape we have three scenarios for next year:
  • Worst Case – Trump is a complete let down and the economy rolls over into recession – mild bear market, 5% chance.
  • Base Case – Trump is moderately successful, but little real change, perhaps too much compromise, economic growth remains tepid – single digit gains to low double digit, 65% chance.
  • Best Case – Trump is largely successful with trimming regulations, tax reform, healthcare reform and infrastructure buildout. The U.S. economy accelerates, growth picks up and appears sustainable – 20%+ gains, 30% chance.
The Trump Administration has many ambitious goals, it all boils down to his success or failure; and we won’t know that until at least some time after January 20 at the earliest. Mr. Trump recently seems to be drifting toward the middle in many areas. His repeal and replace mantra is now more like rework and keep the good, dump the bad. It looks like he will gravitate into comprise mode out of the blocks in order to achieve some quick and early limited success, which will be politically spun as a major victory and high achievement. 
We give base case a 65% chance as he does not appear to have enough congressional support to slam through all that he campaigned on, further rationale for more compromise and less actually delivered. 30% chance for best case is based upon some of his cabinet picks, the way he has been operating as President-Elect, and the mere fact his team did win the election. 5% chance for worst case is based upon the fact he doesn’t like to lose. He will fight and if needed, ultimately compromise to avoid a recession and a bear market. 
Happy Holidays & Happy New Year, we wish you all a healthy and prosperous 2017!