2018 Forecast: Healthy Economy, Strong Market & New Tax Law Bullish – DJIA 29,000 in the Cards By: Jeffrey Hirsch & Christopher Mistal | December 21, 2017 | Email | Print

 

We’ve been digging and searching for indications that this market is running out of steam and we are headed for some sort of major correction, sizeable pullback or a bear market next year, but we have been hard-pressed to find any such data. Sure valuations and sentiment are rather high, but we all know that situation can go on for longer than most bearish investors can stay short or on the sidelines. A growing economy with increasing corporate earnings can bring price/earnings valuations down as well as a price decline. 

 

We do expect a mild soft patch next year during the Worst Six Months (May-October) as is often the case. You might think that such a banner market rally in the usually weak post-election year would “steal” gains from the midterm gains. But that is not really the case. As you can see in the chart below the black line representing midterm years that followed positive post-election years runs extremely close to the blue line of all midterm years. There are other factors at play that have led us to believe next year is likely to be another strong one.

 

 

 

For one thing it is becoming apparent that our 2010 Super Boom Forecast for DJIA to reach 38,820 by the year 2025 is on track. We first released that forecast in this space in May 2010 (starts on page 10 of the June 2010 newsletter) with DJIA around 10,000. We last updated this forecast in March of this year. We now believe that the February 2016 bear market low was the end of the last secular bear and the beginning of the new secular bull market.

 

If you refer to the Bull and Bear Market stats in your handy Stock Trader’s Almanac 2018 on pages 131-132 you will see that the average bull market gain for DJIA is 85.6%, for S&P it’s 81.5% and for NASDAQ it is 129.7%. That equates to about DJIA 29,000. S&P 500 3,300 and NASDAQ 9,800. From here that’s a 17% move for DJIA, 23% for S&P and 40% for NASDAQ.

 

Now, you might be concerned that it’s been a long time since we have had a 10% correction and we are way overdue. It is getting close to two years since the last 10% drop (the aforementioned February 2016 bear market low) and it now stands at 679 days. We are not saying that we will not have a 10% next year; we may very well have one in the worst six months of 2018, but just because we are 164 days over the average timespan between 10% corrections in bull markets does not mean we are overdue for one. The gap from 2011 to 2015 was 1326 days for example. See the rest in our study from August.

 

 

The big horsemen of the economy is the Dow. While it may be an antiquated metric to some it is the oldest continuously tracked market barometer in the book. And it arguable contains 30 of the most influential stocks in the world. Aside from a few blips and minor bears it has been going strong since March 2009. Gains beget gains.

 

Consumer confidence has been on the rise for the past six years and continues to trend higher, suggesting consumers and regular folks are not doing too badly. The unemployment rate continues to fall and sits at 4.1%. And the labor participation rate has begun to rise as workers are coming back into the labor force. When people rejoin the workforce and unemployment stays low, it shows a resilient economy on the verge of accelerating.

 

Inflation as measured by or 6-month exponential moving average calculation on the CPI and PPI is also looking positive just about hitting that sweet spot of 2-5%. CPI is just a hair shy at 1.98%. A little more growth could lead to some wage growth and a healthy rise inflation, allowing the Fed to continue to normalize rates.

 

 

 

Last year we laid out a three part forecast with a worst case scenario, a base case and best case. We gave the Worst Case a 5% chance that President Trump would be “a complete let down and the economy rolls over into recession – mild bear market.” 

 

We gave our Base Case a 65% chance that Mr. Trump would be “moderately successful, but little real change, perhaps too much compromise, economic growth remains tepid – single digit gains to low double digit.” 

 

Our Best Case scenario was given a 30% chance that the President would be “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.”

 

With DJIA up 25% year-to-date, S&P up about 20% and NASDAQ up 29%, we’d say were rather close, but perhaps too conservative. We are not as conservative this year.

 

 

DJIA is currently on track for its best year since at least 2003. Back then DJIA climbed 25.3%. At yesterday’s close (1) DJIA was up 25.1% (+4964.05 points). DJIA has remained above its 200-day moving average since June 2016 and last touched its 50-day moving average in early September of this year. DJIA’s 50-day moving average was just under 23700 at yesterday’s close and it 200-day moving average stood just below 22000.

 

Since issuing our Seasonal MACD Buy signal, DJIA’s faster and slower MACD indicators have remained positive (2), but they are once again stretched. Should DJIA’s momentum falter for any extended period of time, MACD indicators would likely turn negative again. Any such weakness would likely be an opportunity to add to existing positions as many months of the “Best Months” still remain.

 

 

DJIA (3) and S&P 500 (4) have been up four weeks straight and twelve of the last fourteen. NASDAQ’s path to 7000 has not been as smooth having declined twice in the last four weeks (5). Large-cap technology companies, many of which already employed tax reducing strategies, may not benefit as greatly as other sectors of the market from tax reform.

 

Once again NYSE Weekly Advancers and Decliners data has turned murky (6). The robust advantage held by Advancers at the end of November has faded to roughly a 1-to-1 ratio over the past three weeks. This suggests fewer and fewer stocks are participating in the rally. These metrics could also be somewhat distorted by yearend, tax-loss selling.

 

New Highs and New Lows (7) are also giving mixed signals. The decline in New Lows over the past three weeks is encouraging, but the number of New Highs has also been declining. An ideal situation would be for few New Lows and an expanding number of New Highs. Here again, yearend tax-loss selling and traders and investors attempting to find the winners and loser of tax reform could be a factor.

 

With the Fed raising short-term rates and long-term inflation and growth outlooks still on the tepid side, the spread between the 90-Day Treasury rate and the 30-Year Treasury rate continues to shrink (8). This trend has been in place since last December. In 0.25 increments, the Fed would still need to make numerous increases before actually inverting the yield curve. This trend could also reverse if tax reform does have the intended outcome of causing growth to accelerate. Initial impressions suggest it could happen quickly as numerous companies are now planning special bonuses and pay increases once tax reform becomes law. 

 

 

 

Based on everything we have analyzed, including the risks of high market valuations, rocky geopolitics, a new Federal Reserve Chair and the history midterm-election-year volatility we once again have laid out three scenarios for next year:

 

• Worst Case – 5% chance. Full blown midterm bear market caused by North Korea actually setting off a nuke, no positive impact from tax reform, or some other doomsday scenario.

• Base Case – 47.5% chance. Above average midterm year gains in the range of 8-15%, a mild worst six correction or pullback.

• Best Case – 47.5% chance. Everything pans out, tax reform juices corporate earnings, bonuses & paychecks grow, economy grows. DJIA 29,000, S&P 3,300, NASDAQ 9,800

 

The midterm election outcome matters less than many people think with this president. Even if the Democrats take back both houses of Congress President Trump is highly likely to veto any Democratic legislation that comes to his desk. The Dems are not likely to get two-thirds veto override majority. The current Congress and President Trump have put the country on a new path with less regulation and lower taxes. This direction will remain in place until at least January 2021; the next regularly scheduled Inauguration Day.

 

Then there is our January Indicator Trifecta which served us quite well this year. While post-election years are notoriously bearish, when all three January Indicators – the Santa Claus Rally, First Five Days and the full-month January Barometer – are all positive we hit the trifecta. Post-election years since 1949 average about 6.2%. When the January Indicator Trifecta is positive post-election years average 24.0%. 

 

It is a similar case for the midterm year. Average gain since 1950 is 6.7%, but with a positive January Indicator Trifecta midterm years average 21.1% – all based on the S&P 500. So the forecast is out, but as always we reserve the right to make adjustments on the close of January 2018.

 

Happy Holidays & Happy New Year, we wish you all a healthy and prosperous 2018!