January 2018 Trading & Investment Strategy By: | December 21, 2017 | Email | Print

12/20/2017: Dow 24726.65 | S&P 2679.25 | NASDAQ 6960.96 | Russell 2K 1540.08 | NYSE 12747.55 | Value Line Arith 6087.84

 

Psychological: Frothy. Bullish sentiment is running near multi-decade highs according to Investor’s Intelligence Advisors Sentiment survey. It’s the holidays, the market is rising and tax reform is on its way to the President’s desk. Traders and investors should be in “good” spirits.

 

Fundamental: Accelerating. Fourth quarter U.S. GDP is currently forecast at 3.3% by the Atlanta Fed’s GDPNow model and the labor market remains firm with 228,000 net new jobs added in November. These may not be the greatest numbers in history, but they are some of the best in many years. Now add on the potential positive impacts of tax reform and reduced regulation. There seems to be more than sufficient fuel to keep the bull market alive and well.

 

Technical: Overbought. With the exception of Russell 2000, Stochastic, relative strength and MACD indicators applied to xDJIA, S&P 500 and NASDAQ are at or near overbought levels. Recently, similar situations were followed by brief periods of sideways (to slightly lower) trading before the next leg higher occurred. Considering the underlying momentum in the market, this will likely be the case this time around; any weakness could be considered an opportunity to add to existing long positions or to establish new positions.

 

Monetary: 1.25-1.50%. Just as widely expected, the Fed did raise rates at this month’s meeting. Even at the high end of the new range of Fed funds, the rate is still highly supportive of growth and continued firming of the labor market. The Fed’s next meeting ends on January 31 and as of today, CME Group’s FedWatch Tool is showing just a 2.1% probability of another rate increase in January.

 

Seasonal: Bullish. January is the third month of the Best Six/Eight, but it is the last of the Best Consecutive Three month span. January is the top month for NASDAQ (since 1971) averaging 2.5%, but it has slipped to sixth for DJIA and S&P 500 since 1950. Midterm January’s have a troublesome record with average losses for DJIA, S&P 500, NASDAQ, Russell 1000 & 2000. The Santa Claus Rally ends on January 3rd and the First Five Days early-warning system ends on the 8th. Both indicators provide an early indication of what to expect in 2018. However, we will wait until the official results of the January Barometer on January 31 before tweaking our 2018 Annual Forecast. Email Alerts will be sent after the close on these dates.

 

 

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!

 

 

In midterm years, January ranks near the bottom since 1950. Large-caps have been the worst with S&P 500 and Russell 1000 ranking #11 (second worst) and DJIA #10. Technology and small-cap shares fare slightly better in the rankings, but average performance is still negative.

 

 

DJIA and S&P January rankings had slipped precipitously as the month has suffered some significant losses over the last 18 years. From 2000 to 2016 both indices declined 10 times; three in a row from 2008 to 2010 and again 2014 to 2016. January 2009 has the dubious honor of being the worst January on record for DJIA (-8.8%) and S&P 500 (-8.6%) since 1901 and 1931 respectively.

 

On pages 106 and 110 of the Stock Trader’s Almanac 2018 we illustrate that the January Effect, where small caps begin to outperform large caps, actually starts in mid-December. Early signs of the January Effect can be seen by comparing iShares Russell 2000 (IWM) to SPDR S&P 500 (SPY) over the past four trading sessions. IWM is up around 2.1% since the close on December 15 compared to a 1.0% gain for SPY. The majority of small-cap outperformance is normally done by mid-February, but strength can last until mid-May when most indices reach a seasonal high.

 

The first indicator to register a reading in January is the Santa Claus Rally. The seven-trading day period begins on the open on December 22 and ends with the close of trading on January 3. Normally, the S&P 500 posts an average gain of 1.3%. The failure of stocks to rally during this time tends to precede bear markets or times when stocks could be purchased at lower prices later in the year.

 

On January 8, our First Five Days “Early Warning” System will be in. In post-presidential election years this indicator has a solid record. In the last 17 midterm election years, just 8 full years followed the direction of the First Five Days. The full-month January Barometer has a midterm-election-year record of 10 of the last 17 full years following January’s direction.

 

Our flagship indicator, the January Barometer created by Yale Hirsch in 1972, simply states that as the S&P goes in January so goes the year. It came into effect in 1934 after the Twentieth Amendment moved the date that new Congresses convene to the first week of January and Presidential inaugurations to January 20.

 

The long-term record has been astounding, an 86.8% accuracy rate, with only nine major errors in 67 years.  Major errors occurred in the secular bear market years of 1966, 1968, 1982, 2001, 2003, 2009, 2010, 2014 and 2016. The market’s position on January 31 will give us a good read on the year to come. When all the Santa Claus Rally, the First Five Days and January Barometer are in agreement, it has been prudent to heed their call. This January Trifecta was absolutely correct in 2017 correctly predicting a full-year, 20-plus percent gain by S&P 500.

 

 

Our “Free Lunch” strategy is purely a short-term strategy reserved for the nimblest traders. Traders and investors tend to get rid of their losers near yearend for tax loss purposes, often driving these stocks down to bargain levels. Our research has shown that NYSE stocks trading at a new 52-week low on or about December 15 will usually outperform the market by February 15 in the following year. We have found that the most opportune time to compile our list is on the Friday of December triple witching.

 

This strategy takes advantage of several year-end patterns and indicators. First, the stocks selected are usually technically, deeply oversold and poised for a bounce, dead cat or otherwise. Second, all of the stocks are of the small- and mid-cap variety that will benefit from the January Effect which is the tendency for small-caps to outperform large-caps from mid-December through February. Lastly, the strategy spans the usually bullish Santa Claus Rally and the First Five Days of January.

 

To be included in this list, the stock must have traded at a new 52-week low on Friday, December 15, 2017. Then, preferred stocks, funds, splits, special high dividends and new issues were eliminated. To remain on this year’s list, the stock had to still be trading at $1.00 or higher as several online trading platforms place additional restrictions on a trade when shares are below $1.00. Furthermore, the stock must have traded at least 100,000 shares on Friday and have a market cap of at least $50 million, but not greater than $10 billion. Finally, any stock that was not down 50% or more from its 52-week high to the 52-week low reached on Friday was also eliminated.

 

Our suggested guidelines for trading these Free Lunch stocks is to initiate a position at a price no greater or less than 2% of Friday’s closing price and to implement an 8% trailing stop on a closing basis from your execution prices. If the stock closes below 8% of the execution price or a subsequent high watermark, then the stock would be closed out of the portfolio. If any of these stocks trades in a window between -2% to +2% of Friday’s closing price it will be tracked in the Almanac Investor Stock Portfolios using the trade’s execution price with an 8% trailing stop on closing basis.

 

1. Consider selling them as soon as you have a significant gain and utilizing stop losses. 

2. The stocks all behave differently and there is no automatic trigger point to sell at. 

3. Standard trading rules from the Almanac Investor Stock & ETF Portfolios do not apply for these stocks. 

4. We think you should be out of all of these stocks between the middle of January and the middle of February. 

5. Also, be careful not to chase these stocks if they have already run away.

 

 

 

 

Over the long-term, it has not been all that unusual for December to start off mixed and for DJIA, S&P 500 and NASDAQ to be unchanged or even down at the half-way point. This longer-term pattern can be seen in the following chart using data from 1950 through 2016 (1971 to 2016 for NASDAQ). Some of the weakness around mid-month is likely due to tax-related selling and some early end-of-year portfolio restructuring. 

 

Historically weakness has generally come to end just after mid-month around the eleventh trading day and on the fifteenth trading day DJIA, S&P 500 and NASDAQ are generally back on track with a solid rally to wrap up the year. From its mid-month low to the last trading day of the year, NASDAQ has gained over 2% on average. S&P 500 and DJIA have averaged around 1.5%. Based upon December’s long-term pattern, look for the rally to resume between now and early next week.

 

 

 

Over the four weeks since last update, S&P 500 climbed 3.8% higher while Russell 2000 climbed 4.1% as of yesterday’s close. The Almanac Investor Stock Portfolio’s blend of cash and long positions climbed a modest 0.4% over the same time period excluding dividends and any trading costs. Our Large-Cap portfolio performed best, up 2.2% followed by Mid-Caps up 0.1%. Small-Caps were essentially unchanged, 0.04% higher.

 

In the Small-Cap section of the portfolio, Rudolph Tech (RTEC) was added when it traded below its buy limit on November 29. RTEC is a semiconductor equipment maker and has moved lower along with the broader semiconductor sector. The recent pullback in RTEC, and in semis, appears to be a consolidation of gains and nothing more. RTEC can still be considered at current levels up to its buy limit.

 

Cohu Inc (COHU) is another semiconductor equipment supplier. Like RTEC, COHU has weakened recently, but still has not traded below its buy limit. COHU’s buy limit has been raised slightly and a new position can be considered on dips.

 

 

Mid-cap position performance was damaged by Argan Inc (AGX). The position was down last update and plunged through its stop loss on December 7. It was closed out of the portfolio the following day at $45.98. Earnings were the catalyst for the plunge. Year-over-year revenues were up, but down from the previous quarter while earnings also declined.

 

As of today’s close, there are five new positions, KBH, LGIH, MTH, ORBK and PATK, in the Mid-cap portfolio that still have not been filled. Buy limits have all been raised for these stocks. Also note, Patrick Industries split 3 for 2 on December 11.

 

Per last update, the short position in Telsa Inc (TSLA) was covered on November 17 for a modest 6.1% gain. TSLA clearly has lost the momentum it had at the start of the year, but it also refuses to trade under $300 per share for long. Management has numerous innovative ideas that could eventually prove profitable, but the along the road it faces increasing competition along with steep expenses for executing its strategy.

 

Arista Networks (ANET) and UnitedHealth (UNH) continue to be top performers, both currently up over 130% including profits on the sale of half positions. ANET and UNH are on Hold.

 

Absent any real dip in the major indexes over the past four weeks, there are six open positions in the Large-cap portfolio that can still be considered on dips, FAF, G, HII, LII, SNX and TOL. Buy limits and stop losses have been adjusted for these stocks.

 

All other positions in the Stock Portfolio are on hold. Please see following table for current advice, buy limits and stop losses.

 

 

 

Copper has a tendency to make a major seasonal bottom in December and then a tendency to post major seasonal peaks in April or May. This pattern could be due to the buildup of inventories by miners and manufacturers as the building construction season begins in late-winter to early-spring. Auto makers are also preparing for the new car model year that often begins in mid- to late-summer. Traders can look to go long a May futures contract on or about December 14 and hold until about February 23. In this trade’s 45-year history, it has worked 29 times for a success rate of 64.4%. After four straight years of declines, this trade returned to success this year.

 

Cumulative profit, based upon a single futures contract excluding commissions and fees, is a respectable $71,213. More than one-fourth of that profit came in 2007, as the cyclical boom in the commodity market magnified that year’s seasonal price move. However, this trade has produced other big gains per single contract, such as a $14,475 gain in 2011, and even back in 1973, it registered another substantial $9,475 gain. These numbers show this trade can produce big wins and big losses if not properly managed. A basic trailing stop loss could have mitigated many of the losses.

 

 

In the following chart, the front-month copper futures weekly price moves and seasonal pattern are plotted. Typical seasonal strength in copper is highlighted in yellow. Last year’s sizable move immediately following Election Day is evident. Copper also rallied strongly from late-July until mid-October, but has weakened recently potentially setting this trade up nicely. Even at current levels, copper is still well off its highs from 2011 near $4.50 a pound. 

 

 

One option to take advantage of copper’s seasonal move is iPath Bloomberg Copper TR Sub-Index ETN (JJC). As a reminder, ETNs differ from ETFs. An ETN is debt whose current value is based upon an index return. In the case of JJC, it is linked to the Bloomberg Copper Total Return Index, which represents the potential return of an unleveraged investment in copper futures. JJC trading volume is on the light side, trading around 35,000 shares per day on average, but it does pick up when copper moves. JJC could be considered on dips below $33.50. Once purchased a stop loss of $30.95 is suggested. This trade will be tracked in the Almanac Investor ETF Portfolio.

 

 

Another way to gain exposure to copper and its seasonally strong period is through the companies that mine and produce copper. Global X Copper Miners ETF (COPX) holds shares of some of the largest copper miners and producers from across the globe. Its top five holdings as of December 6, 2017 are: Teck Resources, Southern Copper, Freeport-McMoRan, First Quantum and Grupo Mexico. COPX could be considered on dips below $23.50. If purchased, an initial stop loss of $22.25 is suggested. This trade will also be tracked in the ETF Portfolio.

 

 

Oil companies typically come into favor in mid-December and remain so until late April or early May in the following year (yellow box in chart below). This trade has averaged 11.8%, 8.0%, and 9.5% gains over the last 15-, 10-, and 5-year periods, This seasonality is not based upon the commodity itself; rather it is based upon NYSE ARCA Oil & Gas index (XOI). This price-weighted index is composed of major companies that explore for and produce oil and gas. 

 

Crude oil and XOI have been rallying since September on OPEC/Russian supply cuts and improving global growth prospects. Normally during this time the opposite is true as demand is generally waning as the summer driving season has ended and the run up to the winter heating season (a buildup in inventories ahead of anticipated demand) is largely complete. Strength during a typically weak timeframe generally carries over and amplifies gains during seasonally favorable periods.

 

 

SPDR Energy (XLE) is the top pick to trade this seasonality. A new position in XLE could be established on pullbacks with a buy limit of $67.75. Employ a stop loss of $64.50. Take profits at the auto sell of $83.32. Exxon Mobil is the top holding in XLE at 23.25%. The remaining top five holdings of XLE are Chevron, Schlumberger, ConocoPhillips and EOG Resources.

 

 

 

Three sector seasonalities come to an end in December: Gold & Silver, Semiconductor, and Telecom. SPDR Gold (GLD) and iShares Silver (SLV) should be sold. Both positions were trading under their respective stop losses today. For tracking purposes, GLD and SLV will both be closed out of the portfolio using their average prices on Friday, December 8. Higher interest rates, resilient stock markets and perhaps even cryptocurrencies have all weighed on precious metals.

 

iShares DJ US Telecom (IYZ) was stopped out in mid-November. Hold iShares PHLX Semiconductor (SOXX). SOXX suffered a brisk retreat from nearly $182 down to nearly $164 in just eight trading days. This pullback has relative strength, Stochastic and MACD indicators oversold and SOXX appears to have found support and is beginning to turn around.

 

On December 1, iShares NASDAQ Biotech (IBB) split three for one. As a result of the split, IBB’s Presented, Buy Limit, Stop Loss and Auto Sell prices have been adjusted. IBB can still be considered at current prices up to a Buy Limit of $105.00.

 

With the exception of iShares DJ Transports (IYT) and previously mentioned positions, all other positions in the ETF Portfolio can also still be considered when trading below their Buy Limits. The market is consolidating gains from the end of November and could trade sideways to modestly lower until mid-December. Afterwards, the market is likely to finish the year with another respectable rally that continues into the New Year.