December 2018 Trading & Investment Strategy By: | November 29, 2018 | Email | Print

11/28/2018: Dow 25366.43 | S&P 2743.79 | NASDAQ 7291.59 | Russell 2K 1530.38 | NYSE 12417.63 | Value Line Arith 6050.63

 

Psychological: Flat. According to Investor’s Intelligence Advisors Sentiment survey bulls are at 38.3%. Correction advisors are at 41.1% and Bearish advisors are 20.6%. The slow unwinding of bullish sentiment, to the lowest level of bulls since early 2016, is a positive. This would suggest there is additional capital available on the sidelines waiting to be put to work (or short positions that will need covering) when the market begins to rally.

 

Fundamental: Firm-ish. U.S. labor market remains quite firm with unemployment at just 3.7% and 250,000 net new jobs added in October. U.S. GDP is also ok with the Atlanta Fed’s GDPNow model forecasting 2.6% growth for Q4, but is slower than previous quarters. Housing and auto markets are also somewhat tepid. Crude oil’s decline is also noteworthy. Is crude merely reacting to excess supply and sluggish demand or is it possibly indicating slower global growth? Most likely crude’s sell off is an indication of excess supply and waning summertime driving season demand.

 

Technical: Challenged. S&P 500 and NASDAQ are below their respective 50- and 200-day moving averages. DJIA reclaimed its 200-day moving average yesterday. NASDAQ’s chart is the weakest with a “death cross” registering on November 27. One positive thus far is the lows from earlier in the year have held. A break out above early November highs, by all three indices that holds, would be bullish.

 

Monetary: 2.00-2.25%. The Fed remains the single biggest risk to the market and the economy. Rates do need to return to a neutral range, but exactly what neutral is remains unclear. Last month’s rather hawkish tone on interest rates has softened significantly this week as Fed Chairman Powell announced that the Fed’s benchmark rate was “just below the broad range of estimates of the level that would be neutral for the economy.” After nearly a decade at zero, a brief pause to evaluate the impact of recent hikes does not seem unreasonable.

 

Seasonal: Bullish. December is the number one S&P 500 (+1.6%) month and second best for DJIA (+1.7%) since 1950. It’s also the top Russell 2000 (1979) month and second best for NASDAQ (1971) and Russell 1000 (1979). Rarely does the market fall precipitously in December. The “January Effect” of small-cap outperformance starts in mid-December. Wall Street’s only “Free Lunch” of distressed small- and micro-cap stocks making new 52-week lows on December Triple-Witching Friday will be served before the opening bell on December 24. Santa’s Rally begins on Monday December 24 and lasts until the second trading day of the New Year. S&P has averaged gains of 1.3% since 1969. In years when Santa Claus did not come to Wall Street, bear markets or sizable corrections have often materialized in the coming year.

 

It is the season for rallies, but not the Santa Claus Rally quite yet. As I reiterated once again earlier this week on my blog, the Santa Claus Rally is not any seasonal rally in the fourth quarter of the year or around yearend, it is the usual short, sweet, respectable rally Santa brings to Wall Street within the last five days of the year and the first two in January.

 

The Santa Claus Rally was discovered and named by Yale Hirsch in 1972 and published in our 1973 Stock Trader’s Almanac. The Santa Claus Rally is not really a trading strategy it is an indicator, the first of our January Indicator Trifecta (more on that next month). Santa’s failure to show tends to precede bear markets, or times stocks could be purchased later in the year at much lower prices. To Wit, “If Santa Claus Should Fail To Call, Bears May Come To Broad and Wall.”

 

Santa Claus may not be coming to town until the end of December, but there is still plenty of market upside to be had seasonally and historically at present. Our good friend and options guru Larry McMillan enjoys a seasonal trade as well and has combined post-Thanksgiving bullishness, the “January Effect” of small cap stocks outperforming big cap stocks that now takes place in mid-December (pages 108 & 110 of the 2018 or 2019 Stock Trader’s Almanac.) with our Santa Claus Rally and goes long the Russell 2000 index of small cap stocks from the day before Thanksgiving through the second trading day of the New Year.

 

So I ran the numbers on that timeframe for the Dow, S&P 500, NASDAQ Composite and Russell 2000. As you can see in the table below small caps clearly outperform large caps over this period with an 82% win ratio and average gains of 3.4% since inception in 1979. The big caps and NASDAQ don’t do too shabby either. The Dow and S&P log near an 80% win ratio with average gains around 2.5% since 1950 and NASDAQ has a 74.5% winning percentage with average gains if 2.85% since 1971 though median gains are 2.15%, reflecting some outsized gains over the years.

 

 

The rest of December’s market stocking is also stuffed rather full, but the first half of the month is usually weaker than the second half as tax loss selling dominates trading. As mentioned above small caps tend to begin to outpace large caps around mid-December and then we serve up Wall Street’s only “Free Lunch” just before Christmas (Almanac page 112). 

 

From the list of stocks making new 52-week lows on December 21, 2018 we compile our menu of “Free Lunch” stocks poised for a bounce-back rally and email them to subscribers before the open on December 24. Since 1975 this list of stocks has beaten the NYSE Composite by 9.1% on average with an average gain of 12.1% vs. 3.0% for the index. 

 

Since our most recent bout of “Octoberphobia” that reaffirmed “Sell in May” is not dead and our Tactical Seasonal Best Months MACD Buy Signal on October 31, the market has been attempting to rally, albeit in fits and starts. We have been saying for months, especially in our “Market at a Glance,” that the Fed is the biggest risk to the market and the economy and now Chairman Powell’s kind words this week sent the market soaring back. 

 

But there is still work to do and risks abound. Yes, we are still bullish on the “Sweet Spot” of the 4-Year Cycle from Q4 in the midterm year through Q2 of the pre-election year (Q4 2018-Q2 2019), but we are concerned after that and will layout our full Annual Forecast for 2019 next month on December 20 as we do every year. 2017’s Base Case 2018 Forecast is still in play.

 

Finally, technically speaking we are tracing out a potential “W-1-2-3 Swing Bottom” pattern as shown in the graph below. If we can clear the midpoint of the “W” at point 2 in the chart, at the early November highs, that would be constructive for the market to move to new highs. Once we clear that level, it becomes support and if breached again to the downside it would be concerning. The rising trend from point 1 to point 3 in the graph is also encouraging.

 

 

 

On the close on October 31, the “Best Months” began and our Seasonal Buy Signal for DJIA, S&P 500 and NASDAQ was issued. In the time since, DJIA was higher, briefly reclaiming its 50-day moving average, then moved lower, below both its 50- and 200-day moving averages and is now moving higher again (1). DJIA is currently above its 200-day moving average, but could run into some resistance around its 50-day moving average. During this wild ride, both the faster and slower moving MACD indicators (2) did turn negative, but the faster moving indicator is now positive again and the slower moving is on the verge of becoming positive.

 

 

Typical seasonal bullishness around Thanksgiving was canceled this year. DJIA declined over 1100 points (4.4%) during the holiday shortened week (3). This was DJIA’s worst weekly performance since March. S&P 500 (4) and NASDAQ (5) suffered similarly sizable declines. The last time the market declined a similar magnitude during Thanksgiving week was in 2011 when the Greek debt crisis struck. In 2011, S&P 500 rallied 8.5% during the rest of the year, but still finished the year fractionally in the red with a 0.003% decline.

 

Market breath measured by NYSE Weekly Advancers and NYSE Weekly Decliners was positive during the first two weeks of November, but turned decidedly negative during the third and four weeks (6). During last week’s test of October lows Weekly Decliners outnumbered advancers by nearly 3.5 to 1 which was an improvement over early October readings that reached nearly 5.3 to 1. This would appear to suggest that selling pressure has begun to fade as fewer stocks declined during last week’s retest.

 

Weekly New Highs and New Lows reacted as one would expect during a brisk retreat. New Lows (7) exploded to their highest level since February 2016 while New Highs declined to their lowest level also since February 2016. A sustained trend of expanding highs and declining lows would be an encouraging sign of a solid rally.

 

90-day Treasury rate continues to climb (8) reaching 2.35% last week while the 30-year Treasury rate declined for the first time since early August. The modest decline in the 30-year rate in August preceded three-straight weekly gains by DJIA and S&P 500.

 

 

 

Trading in December is holiday inspired and fueled by a buying bias throughout the month. However, the first part of the month tends to be weaker as tax-loss selling and yearend portfolio restructuring begins. Regardless, December is laden with market seasonality and important events. 

 

Small caps tend to start to outperform larger caps near the middle of the month (early January Effect) and our “Free Lunch” strategy is served from the offerings of stocks making new 52-week lows on Triple-Witching Friday. An Almanac Investor Alert will be sent prior to the open on December 24 containing “Free Lunch” stock selections. The “Santa Claus Rally” begins on the open on Christmas Eve day and lasts until the second trading day of 2019. Average S&P 500 gains over this seven trading-day range since 1969 are a respectable 1.3%. 

 

This is the first indicator for the market in the New Year. Years when the Santa Claus Rally (SCR) has failed to materialize are often flat or down. The last six times SCR (the last five trading days of the year and the first two trading days of the New Year) has not occurred were followed by three flat years (1994, 2004 and 2015) and two nasty bear markets (2000 and 2008) and a mild bear that ended in February 2016. As Yale Hirsch’s now famous line states, “If Santa Claus should fail to call, bears may come to Broad and Wall.”

 

In the last seventeen midterm years, December’s rankings slip modestly to #3 S&P 500 (1.8%) and DJIA (1.5%) and #5 NASDAQ (0.6% since 1974). Small caps, measured by the Russell 2000, also perform well in midterm Decembers. Since 1982, the Russell 2000 has lost ground just twice in nine midterm years in December. The average small cap gain in all nine years is 0.7%. In 2010, Russell 2000 gained 7.8% in December.

 

 

December Triple Witching Week is more favorable to the S&P 500 with Monday up twelve of the last eighteen years while Triple-Witching Friday is up twenty-five of the last thirty-six years with an average 0.3% gain. The entire week has logged gains twenty-six times in the last thirty-four years. The week after December Triple Witching is the best of all weeks after Triple Witching for DJIA and is the only one with a clearly bullish bias, advancing in twenty-six of the last thirty-five years. However, three straight years of declines from 2006-2008 and 2012 have tempered its bullish bias. Small caps shine especially bright with a string of bullish days that runs from December 20 to 26.

 

Trading the day before and the day after Christmas is generally bullish across the board with the greatest gains coming from the day before (DJIA up eight of the last eleven). On the last trading day of the year, NASDAQ has been down in fifteen of the last eighteen years after having been up twenty-nine years in a row from 1971 to 1999. DJIA, S&P 500, and Russell 1000 have also been struggling recently and exhibit a bearish bias over the last twenty-one years. Russell 2000’s record very closely resembles NASDAQ, gains every year from 1979 to 1999 and only four advances since.

 

 

Of the six combinations of political alignment possible for the White House, the House of Representatives and the Senate, the best combination for DJIA from 1949 through the end of 2017 has been a Democrat in the White House and Congress controlled by the Republic Party with average annual gains of 16.1%. Second best was a Republican in the White House with a Republican Congress at 15.6%. Both of these results compare favorably with the average performance in all years of 8.6%.

 

 

Over the same time period, the worst combination for DJIA performance was a Republican President and full Democratic control of Congress with an annual average gain of just 4.9%. Under a Republican President and a split Congress, which is the current situation, DJIA has averaged gains of 6.7%. This is neither the best nor the worst historically and considering the age of the current bull market perhaps quite acceptable for the next two years.

 

 

Over the last two weeks since last update, S&P 500 slipped 0.4% through yesterday’s close. Russell 2000 was 0.6% lower over the same time period. Overall, the entire Stock Portfolio slipped 1.1% excluding any dividends or trading fees. Mid-caps were hit the hardest, down 4.0%. Small-caps were second worst dipping 0.5%. Our Large-cap portfolio, with the largest concentration of defensive stocks, gained 0.2%. Compared to the S&P 500, the overall portfolio lagged due to the recent pullback and the addition of all of last week’s new stocks.

 

All twenty new ideas in our November Stock Basket were added to the portfolio on November 9. Buy limits for the new positions were not far above or below current prices at the time as a multi-day streak of market declines did not appear highly possible. However, that is exactly what transpired and all 20 new stocks are currently in the red. 

 

Lumentum Holdings (LITE) is the worst performer of the basket and was stopped out on November 12. The catalyst for the steep single-day decline was an announcement from management that it was cutting its guidance after a large and substantial customer requested its order be reduced. The cut in second-quarter 2019 guidance for revenue and earnings was quite large at nearly 20%. Margins were also guided lower. In light of this recent development, we will pass on LITE.

 

Of the remaining 19 new stock trade ideas in last week’s basket, all can be considered at current levels up to their respective buy limits. 

 

June’s basket of Defensive Stocks continues to perform well. Gains in the Large-cap section of the portfolio came nearly entirely from defensive positions and were sufficient to offset the mild declines recorded by the addition of new positions. Of the original 21 stocks selected fifteen are still held. Fourteen are positive with an average gain of 14.1%, one is negative (Conagra (CAG)) and five were stopped out. Including the stopped positions, the basket’s average performance is 7.9% compared to a loss of 2.9% by S&P 500 over the same time period excluding any dividends.

 

The best performing defensive position is still McCormick & Company (MKC), up 39.4% as of yesterday’s close. Second best is Church & Dwight (CHD) up 31.7% at yesterday’s close. AQN, NJR, OGS, ABT, AEE, CMS, EXC and UGI are up double-digit.

 

There are three positions in the Large-cap section that are going to be closed out. Sell Altria Group (MO), Sysco (SYY) and Conagra (CAG). All three have declined over the last two weeks and appear to be shaky ground. For tracking purposes all three will be closed out using their respective average prices in Friday, November 16.

 

All remaining defensive positions and longer-term holdings are on Hold. Please see portfolio table below for Current Advice, Stop Losses and Buy Limits where applicable.

 

 

Following our MACD Seasonal Buy Signal issued on October 31, 2018 the post-midterm election rally has boosted the ETFs in our Sector Rotation and Tactical Seasonal Switching Strategy Portfolios. 

 

At the start of October, before the market correction, we put out nine new ETF trade ideas with seasonalities that historically begin in the month of October. The correction whipsawed us in and out of IYT, SOXX, XLI and XLB. In accordance with our October 31 Buy Alert, these positions have been added to the portfolio using the average price on November 1 or the Buy Limit, whichever was lower.

 

Positions in IYZ, XLY, XLF, XLK and VNQ were entered at our buy limits, but did not get stopped out. In accordance with our October 31 Buy Alert, we added to these existing positions using the average price on November 1 or the Buy Limit, whichever was lower. Original prices have been updated to reflect the additional position.

 

Buy limits, stop losses and auto-sell prices have been updated throughout the Sector Rotation Portfolio to reflect the changes made in past two Alerts on October 31 and November 1. Please see the following table for individual ETF advice and prices.

 

 

 

As per the past two Alerts on October 31 and November 1, updated buy limits and advice appear in the table below. This table contains all trades made in execution of our Tactical Seasonal Switching Strategy. This strategy is also known as the “Best Months” or “Sell in May.” Positions in DIA, IWM, QQQ and SPY are equal-weighted in the strategy and initially will be held without a stop loss.

 

 

This basket is being presented in order to take advantage of the “Sweet Spot” of the four-year cycle (Q4 of midterm year through Q2 of pre-presidential-election year) for stocks. We will look to add these 20 stocks, in the table below, near current levels or on minor dips. We will allocate a hypothetical $2000 from the cash position in the portfolio to each position. For each stock we have provided the ticker, name, sector, general business description, plus annual sales growth, PE, price-to-sales ratio, market value, a dividend yield and a suggested buy limit and stop loss.

 

These 20 stocks all have reasonably solid valuations, healthy revenue and earnings growth, while exhibiting positive price and volume action as well as other constructive technical and chart pattern indications. The group of 20 covers a broad array of sectors and industries. It also runs the gamut of market capitalization with a mix of large caps with more than $5 billion in market value, midcaps in the $1-5 billion range, and small caps under $1 billion.

 

We first sifted through the universe of nearly 8,000 U.S. traded stocks for those with a market cap of at least $50 million and average daily volume of 50,000 shares or more on average over the past twenty trading sessions. Then we winnowed the list down to only those stocks with relatively low price-to-sales and price-to-earnings ratios. From there we searched for stocks that were exhibiting revenue and earnings growth.

 

We then dug into numerous individual company charts before settling on these final 20 stocks. Our underlying theme was to find reasonably priced stocks quietly growing sales and earnings that are flying somewhat under the radar with few on The Street paying close attention to them. As market cap goes higher, this becomes increasingly challenging and a history of earnings surprises becomes even more important. 

 

At the end of the screening process we found that computer technology, energy and retail industries were well represented in the basket. We did not search specifically for top-performing stocks within these sectors, this just happens to be where relative value and growth currently exist.

 

 

This past midterm-year October that ended yesterday finished well below expectations and historical averages. DJIA declined 5.1%, S&P 500 dropped 6.9% and NASDAQ was off 9.2%. October’s losses were the seventh worst decline for DJIA since 1950, fourth worst for S&P 500 and fifth worst for NASDAQ since 1971. Historically, November and December market performance did hold up following a negative October.

 

 

In the above table every down October for DJIA, S&P 500 and NASDAQ have been compiled along with their respective performance in November and December. Compared to all Octobers, DJIA and S&P 500 performance improved in November and December when October suffered a decline. DJIA’s average performance in November and December after an October decline improved to 2.3% and 1.9% compared to average gains of 1.6% and 1.7% respectively in all years. S&P 500 in November had a modestly weaker average performance following a down October, but December was notably stronger. NASDAQ’s November performance after an October decline is worse than average, but the results are heavily skewed by double-digit declines in 1973, 2000 and 2008.

 

Even better and perhaps of greater relevance is the performance of November and December in past midterm years where October was down (shaded in grey and italics in table). All midterm Novembers and Decembers were positive and average performance was nearly double or better.

 

 

Over the last three weeks since last update, S&P 500 declined 2.7% through yesterday’s close. Russell 2000 dropped 4.1% over the same time period. Overall, the entire Stock Portfolio slipped 0.9% excluding any dividends or trading fees. Mid-caps were hit the hardest, down 3.3%. Small-caps were second worst dipping 0.8%. Our Large-cap portfolio, with the largest concentration of defensive stocks, gained 1.7%. Compared to the S&P 500, the overall portfolio outperformed due to a sizable cash position and strength from a number of positions from June’s Defensive Basket.

 

June’s basket of Defensive Stocks is performing reasonable well. Of the original 21 stocks selected fifteen are still held. Fourteen are positive with an average gain of 11.5%, one is negative, five were stopped out and Pinnacle Foods (PF) merged with Conagra Brands (CAG). Including the stopped positions, the basket’s average performance is 5.7% compared to a loss of 2.5% by S&P 500 over the same time period excluding any dividends.

 

CAG’s acquisition of PF was announced back in late June and was completed on October 26. For each share of PF held, shareholders received 0.6494 shares of CAG and $43.11 in cash. The new shares of CAG appear in the table below while the cash was added to the cash balance.

 

October’s rout did result in three stock positions being stopped out. Small-cap CoHu Inc (COHU) was stopped out on October 23. Mid-cap stocks Western Alliance (WAL) and Orbotech Ltd (ORBK) were also stopped out. A modest 4.6% gain was realized by ORBK. WAL was closed out for a 39% gain while COHU was stopped out for a mild 6.7% loss.

 

The best performing defensive position is still McCormick & Company (MKC), now up 35.9%% as of yesterday’s close. Second best is Church & Dwight (CHD) up 19.4% at yesterday’s close and up another 9.3% today. OGS, MO, AEE and CMS are also enjoying double-digit gains. All positions in the stock portfolio are on Hold for now. Next week we anticipate compiling and releasing a new basket of stocks meticulously selected to take full advantage of the “Best Months.”  

 

Please see portfolio table below for updated stop loss suggestions.

 

 

 

At the start of October, before the market’s decline accelerated, we put out nine new ETF trade ideas with seasonalities that historically begin in the month of October. At that time, buy limits were reasonably below market prices, but ultimately proved to be not low enough. As a result, IYT, SOXX, XLI and XLB were added to the portfolio and subsequently stopped out. Losses in these positions have been recognized in the portfolio and new trades have been presented. IYT, SOXX, XLI and XLB can be bought at or near current levels up to their respective buy limits. In accordance with yesterday’s Buy Alert, these positions will be added to the portfolio using today’s average price.

 

Other new October trade ideas in IYZ, XLY, XLF, XLK and VNQ have been added to the portfolio and can also be considered at or near current levels up to their respective buy limits. In accordance with yesterday’s Buy Alert, we added to these existing positions today using average daily prices. Original prices will be updated to reflect the additional position.

 

Buy limits, stop losses and auto-sell prices have been updated throughout the Sector Rotation portfolio to reflect the changes made in yesterday’s Buy Alert. Please see the following table for individual ETF advice and prices.

 

 

 

Per yesterday’s Buy Alert, updated buy limits and advice appear in the table below. This table will contain all trades made in execution of our Tactical Seasonal Switching Strategy. This strategy is also known as the “Best Months” or “Sell in May.” Positions in DIA, IWM, QQQ and SPY are equal-weighted in the strategy and initially will be held without a stop loss.

 

 

Faster moving MACD “Buy” indicators applied to DJIA, S&P 500 and NASDAQ are all positive as of today’s close. At the highs of the day, the crossover was clear in the charts below (blue arrows), but at the close only DJIA’s crossover is clearly visible. Regardless of the crossover’s magnitude, the criteria to issue our Seasonal MACD Buy Signal have been satisfied. With all three indices confirming, we are now issuing our Seasonal MACD Buy Signal.

 

 

Buy SPDR DJIA (DIA), SPDR S&P 500 (SPY), Invesco QQQ (QQQ), and iShares Russell 2000 (IWM) in the Almanac Investor Tactical Seasonal Switching Strategy Portfolio. For tracking purposes, these ETFs will be added to the portfolio using their respective average prices on November 1. This price will be calculated by summing the high and low prices and dividing by two. Buy limits for DIA, SPY, QQQ and IWM are initially today’s closing price plus 1%. For example if today’s closing price was $100, then the buy limit would be $101 (close * 1.01 = buy limit).

 

In the Almanac Investor Sector Rotation Portfolio, Buy XLV, XLP, IYW, IYT, IYZ, SOXX, XLY, XLF, XLI, XLB, XLK and VNQ. For tracking purposes, these ETFs will be added to the portfolio using their respective average prices on November 1. Use a 1% Buy Limit for these positions as well as detailed above. IYW, IYZ, XLY, XLF, XLK and VNQ are already held in the portfolio, but we are going to add to these existing positions. IYT, SOXX, XLI and XLB were added earlier in October and stopped out near the end. Establish new positions in these four ETFS.

 

Sell iShares US Aggregate Bond (AGG). iShares 20+ Year Bond (TLT) was stopped out on October 5 and SPDR Utilities (XLU) was stopped out on October 11 when it closed below its 1% trailing stop loss.

 

The Almanac Investor Stock and ETF Portfolios will be updated in the next regularly scheduled Alert tomorrow Thursday, November 1.