December 2016 Trading & Investment Strategy By: | November 29, 2016 | Email | Print

11/28/2016: Dow 19097.90 | S&P 2201.72 | NASDAQ 5368.81 | Russell 2K 1329.83 | NYSE 10808.63 | Value Line Arith 5185.53

 

Psychological: Holiday Cheer. DJIA, S&P 500, Russell 1000 and Russell 2000 all advanced every day of Thanksgiving week. Even so, there are still plenty of skeptics out there that believe the rally will not last keeping overall sentiment essentially neutral. Weekly CBOE Put/Call ratio at 0.60 confirms it. 

 

Fundamental: Better, still not great. Third quarter GPD was revised higher to 3.2% while the unemployment rate is holding steady around 5%. Corporate earnings also posted their first year-over-year advance in five quarters. The consumer also appears to be picking up the pace of spending. The economy may not yet be running on all eight cylinders, but it appears to be headed in that direction once again. 

 

Technical: Broken out. For the first time in over a year all major indices, DJIA, S&P 500, NASDAQ and Russell 2000 have broken out to new all-time highs together. The buying spree may be getting a touch stretched suggesting the market may be due a rest, but once rested the market will likely resume its run higher.

 

Monetary: 0.25-0.50%. Interest rates have moved higher and the Fed appears to be ready and willing to raise the Fed Funds rate this December. Either they do or they don’t. Most expect a rate increase and we will know for sure on December 14. Regardless, rates remain accommodative relative to historical levels. 

 

Seasonal: Bullish. December is the number one S&P 500 month and second best for DJIA since 1950, averaging gains of 1.6% on each index. It’s also the top Russell 2000 (1979) month and second best for NASDAQ (1971) and third best for Russell 1000 (1979). Rarely does the market fall precipitously in December. In election years, average performance does weaken modestly. The “January Effect” of small-cap outperformance starts early 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 19. Santa’s Rally begins on Friday December 23 and lasts until the second trading day of the New Year. S&P has averaged gains of 1.5% 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.

 

Market strength tends to beget more strength and a greater frequency of new highs usually perpetuates higher highs. All major indices hit new all-time highs last Friday. But many folks on The Street are worried that the Trump rally can’t last and that valuations have gotten way ahead of underlying value. Truth is this rally or any rally doesn’t last forever. But this rally has legs and is not likely to get derailed until a new Trump administration fumbles, falters and really screws something up. And that can’t officially happen until January 20 when Trump takes office.

 

This rally’s legs are supported by a few main pillars. First, growth appears to have picked up and turned the corner. 2016 Q3 GDP was revised higher today, rising at a rate of 3.2% annually. With nearly all S&P 500 index companies reporting results, profits were set to rise 4.2% in the third quarter of 2016, likely ending the streak of five consecutive quarterly earnings declines.

 

Secondly, although the Fed is extremely likely to raise rates in two weeks (CME Group FedWatch tool has the probability now at 96.3%), the Fed Funds rates will remain historically low at well under 1%. Perhaps the Fed’s “fake it ‘til you make it” mantra is finally paying off and the economy is beginning to grow organically. The fact that they are actually finally ready to raise rates again is the clearest sign the economy is growing on its own. The Fed may yet prove to have been too late in raising rates, causing rampant inflation down the road, but that is some time off and not likely to impact us until after the first 100 days of the Trump Administration or later in Q2 at the earliest.

 

That brings us to the third pillar: Trump. Whatever your ideology or however you voted, Donald Trump is our next President. And he likely brings about the greatest potential for change in U.S. government policy since the mid-1970s and early 1980s. Rates were at the other end of the spectrum and market has performed much better currently. But it’s a different world now and we are arguably at a similar inflection point at the outset of another secular economic boom and bull market. 

 

There will be setbacks along the way and bear markets and even a recession, but we are at the beginning of the next technological leap for humanity and the planet earth. Artificial intelligence and robotics are on the verge of surpassing human capabilities. Biotech is nearing the holy grail of cracking the genome and curing many diseases. And Energy tech is making breakthroughs that are poised to change the way each and every one of us lives.

 

But for now, the market is responding to this potential for real constructive change in US government policy that stimulates growth and gets a little more out of the way of the private sector. It remains to be seen if Trump can execute, but the market is already betting he’ll have some positive impact. The major areas of rapture for Wall Street are building out and rebuilding the country’s infrastructure, reducing taxes and regulation and focusing on policies that stimulate the domestic economy. The last tax cut we had in the U.S. was 2001, but Trumps tax cuts are being billed as the most comprehensive since Reagan. As we want to make painfully clear, any Trump Administration stumbles early next year could quickly derail this rally.

 

The other thing we want you to be on the lookout for is any early December weakness. Early December is notoriously weak due to tax-loss selling, check the December Almanac (Stock Trader’s Almanac page 108). We think this will be another solid buying opportunity, so be patient if you missed some of the rally and wait for the typical December weakness to take additional long positions.

 

The thing we are concerned about with this December’s tax-loss selling season are the prospective Trump tax cuts and loophole closures next year. There are two scenarios we envision. First, folks think that tax rates will be lower next year and Trump will keep the loopholes to benefit corporations and high-net worth people he believes will stimulate the economy. This creates less tax loss selling this year as everyone waits for lower rates and gets the same loopholes next year.

 

Or the more likely case where Trump has to compromise by getting rid of loopholes to get tax rates down. This would likely keep tax-loss selling at a normal or increased level as everyone tries to take advantage of the existing loopholes this year. Bottom line, get ready to take advantage of any December weakness to buy U.S. equities, sector ETFs and major market ETFs. Ride the Trump revived economic growth rally at least until Inauguration Day or the first 100 days. But be ready to take some profits next year as new policy initiatives shake things up near the end of the Best Six Months.

 

 

Our Seasonal MACD Buy Signal issued after the market’s close on October 24 came several days early as the market slipped ahead of Election Day. Buying weakness, as our signals were suggesting, proved correct as the market roared back to life on November 7 and has not looked back since. DJIA (1) was first to breakout to new all-time highs while S&P 500, NASDAQ, Russell 1000 and 2000 quickly followed suit.

 

DJIA is on the verge of gaining 1000 points this month. This feat has been accomplished in just four other months; March 2016, October 2015, October 2011 and April 1999. This brisk upside momentum has lifted both the faster and slower moving MACD indicators applied to DJIA toward over bought levels (2). It is not uncommon for the market to falter in the first half of December and the market does appear to be setting up once again for at least a period of consolidation and/or mild pullback before resuming its march higher.

 

 

The current market rally took hold after a week of losses that was preceded by the ninth Down Friday/Down Monday (DF/DM) (3) of 2016 on October 31. This occurrence was followed by immediate and persistent declines that adequately fulfilled the cautionary aspects of the warning. Four weeks later, DJIA (4) is at new all-time highs and trading above 19000 for the first time ever.

 

S&P 500 (5) and NASDAQ (6) have also been up three weeks in a row and are also trading at new all-time highs. Across the board new all-time highs is bullish and is likely to lead to even more new highs.

 

NYSE Weekly Advancers and Decliners (7) have been behaving as expected. Weekly advancers were robust last week which suggests broad participation in the current rally. Again, this is bullish as it indicates most stocks are climbing, not just a limited number of high flyers.

 

NYSE Weekly New Highs (8) made an abrupt reversal during the second week of November while New Lows continued to expand until last week. This behavior can be attributed to a rotation out of defensive, often rate-sensitive stocks into areas of growth or at least potential growth under a new administration in Washington. The move out of safe havens can also be seen in the rise in 90-day and 30-Year Treasury rates (9). Since the jump in rates easily exceeds the expected Fed increase in December, growth and inflation outlook improvements probably account for the balance of the move.

 

Provided President-Elect Trump is successful in his first 100 days in office, the market appears poised for further gains. Major indices have decisively broken out to new all-time highs, there is broad participation in the rally and there has been a rotation out of defensive sectors and positions.

 

 

 

Market 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 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 19 containing “Free Lunch” stock selections. The “Santa Claus Rally” begins on Friday December 23 and lasts until the second trading day of 2017. Average S&P 500 gains over this seven trading-day range since 1969 are solid 1.4%. 

 

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. Of the last four 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 two flat years (1994 and 2004) and two nasty bear markets in 2000 and 2008. 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 sixteen election years, December’s ranking slip modestly to #3 S&P 500, #5 NASDAQ, but DJIA remains #2. Small caps, measured by the Russell 2000, have had a field day in election-year Decembers. Since 1980, the Russell 2000 has lost ground just once in nine election years in December. The average small cap gain in all nine years is a solid 3.0%. The Russell 2000’s single loss was in 1980 when the Prime Rate was 21.5%.

 

 

December Triple Witching Week is more favorable to the S&P 500 with Monday up eleven of the last sixteen years while Triple Witching Friday is up twenty-four of the last thirty-four years with an average 0.4% gain. The entire week has logged gains twenty-five times in the last thirty-two 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-four of the last thirty-four years. However, three straight years of declines from 2006-2008 have tempered its bullish bias. Small caps shine especially bright the week after Triple Witching with a string of five bullish days in a row.

 

Trading the day before and the day after Christmas is generally bullish across the board with the greatest gains coming from the day before. On the last trading day of the year, NASDAQ has been down in fourteen of the last sixteen 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 clearly bearish bias over the last twenty-one years. Russell 2000 record very closely resembles the NASDAQ, gains every year from 1979 to 1999 and just four advances since.

 

Last week the Russell 2000 index of small-cap stocks enjoyed its sixth best weekly gain ever, up 10.2%. It narrowly missed besting its most recent and fifth place overall 10.3% weekly gain from December 2, 2011. Russell 2000 is also trading at new all-time highs above 1300. Small caps have finally caught up. Technology shares are now the laggard that is holding back market.

 

 

Looking at the above four charts we can see DJIA and Russell 2000 have broken out to trade at new all-time highs while NASDAQ and S&P 500 have not. Today’s gains have moved S&P 500 and NASDAQ closer to breaking out, but their respective old highs appear to be formable resistance. If S&P 500 and NASDAQ can break out and join DJIA and Russell 2000 with new all-time highs, then this rally has much better odds of surviving to yearend and beyond.

 

 

In the three weeks since last update, S&P 500 was up 1.6% while Russell 2000 gained a whopping 7.1% as of yesterday’s close. The Almanac Investor Stock Portfolio’s blend of cash and long positions resulted in a respectable 2.6% overall gain over the same time period. Large-cap stocks in our portfolio performed best, advancing 4.1%. Small-caps were second best climbing 2.9% while Mid-caps lagged, up just 1%.

 

The market’s slid into Election Day, S&P 500 down nine consecutive days, did offer ample opportunity to “buy the dip.” Over the course of its nine-day slid, S&P 500 shed 3.1% while numerous individual stocks dropped even further. During this downdraft, IES Holdings (IESC) and Century Communities (CCS) were added to the Small-cap portfolio. IESC and CCS are now up 22% and 5.9% respectively.

 

When the slid ended, on the historically bullish day before Election Day, it rebounded and DJIA was up seven days in a row. This broad strength (outside of technology) resulted in significant gains for several positions within the portfolio. Sucampo Pharma (SCMP) was down 0.5% last update and as of yesterday’s close is now up 27.8%. Lydall Inc. (LDL) also surged from a gain of 38.9% to 70.4%. Bank stocks performed exceptionally well on prospects of a steeper yield curve and possible less regulation under a new administration. Ameris Bancorp (ABCB) and Western Alliance (WAL) are now showing gains of 22.3% and 23.3%.

 

Only Sabra Healthcare REIT (SBRA) and Corelogic Inc. (CLGX) are currently in the red. SBRA is interest rate sensitive and is being pressured by higher rates, but because it is healthcare, its downside is likely limited. CLGX appears to have gotten wrapped up in the Silicon Valley tech sell off that ensued following election results, but it has already begun to rebound with other technology shares.

 

Four trade ideas have run away and are being cancelled. AV Homes Inc (AVHI), Preferred Bank (PFBC), United Community Bank (UCBI) and Semiconductor MFG-ADR (SMI) trade ideas are all cancelled. AVHI, PFBC and UCBI all traded within a few cents of their respective buy limits sometime in October or early November, but never below and are now significantly above. We will not chase. 

 

Please refer to the updated portfolio table below for Current Advice about each specific position. Also note that many stop losses have been updated.

 

 

 

This extraordinary forecast was and is based upon the seminal research and reports our founder undertook and published back in the mid-seventies. Yale Hirsch, who just celebrated his 93rd birthday discovered this iconic market cycle, which led him to the greatest market call in history for a 500% move in the market from the 1974 low to 1990. After publishing several articles over the previous three years that the market had hit bottom in the fall of 1974, Yale released his April 1976 newsletter with the headline “Stocks Catch Up with Inflation Eventually, 500% Moves After Both WW1 & WW2, Can It Happen Again? Dow 3420?" Well, it did. Following Vietnam and the rampant stagflation of the 1970s DJIA hit 3420 in May of 1992. S&P 500 completed its 500% move in July of 1990.

 

Yale’s 1977 Special Report opens with: “A Super-Boom rarely comes more than once in a generation. Unfortunately, it seems to follow a severely inflationary era which destroys stock values and leaves investors demoralized and disenchanted. Consequently, when the market begins its phoenix-like rise out of the ashes, the average investor, “scarred” and still remembering the pain of the past, fails to recognize the genuine buying opportunity of his lifetime. This report presents what I believe to be the most convincing evidence that a Super-Boom has already begun and is now in progress. Don’t be late!”

 

We began tracking this cycle again in 2002 after 9-11 and the 2002 bear market. As we went to press in May 2010 with the Stock Trader’s Almanac 2011 which included this forecast we published this headline and excerpt in our newsletter at the time. “Next Super Boom – Dow 38820 by 2025 – Stocks Catch up with Inflation, But First Inflation Catches up with Government Spending: As markets and economies struggle over the next several years, remember to keep your eye on the future and get ready for the Next Super Boom and the next 500% move in the market. From the last bottom in 1974 it took eight years before the market really took off in 1982 and then another eight to move up the rest of the 500%, in line with Yale Hirsch’s prediction in 1976 for a 500% market move by 1990. A 500% rise in the Dow over 16 years from the intraday low of 6470 on March 6, 2009 would put the Dow at 38,820 in 2025.”

 

At that time in 2010 DJIA was around 10,000, unemployment was quite high, the great recession was barely in the rearview, and global debt was a new and growing concern. So our prediction that the Dow would reach 38820 by 2025 seemed absurd to many when we announced it. That came as no surprise—all cutting-edge predictions are first lambasted before proven true. This super boom is not only plausible, but mathematically and historically within reason. Now that DJIA has exceeded 18,000 it looks even more credulous. Every truth passes through three stages before it is recognized. In the first it is ridiculed; in the second it is opposed; in the third it is regarded as self-evident. — Arthur Schopenhauer (German philosopher, 1788-1860)

 

As we developed this forecast further for our 2011 book Super Boom: Why the Dow Jones Will Hit 38,820 and How You Can Profit From It (Wiley) we discovered the other variables of the Boom Equation. In addition to war and inflation several factors came into alignment that ignited prior Super Booms and Secular Bull Markets, including a properly function government that is in synch with the private sector, stimulating innovation and robust economic growth. The final factor is what we call a culturally-enabling-paradigm-shifting technology – something that changes the world and touches and changes the lives of humans individually across the planet. Indoor Plumbing. The Steam Engine. Electricity. Automobiles. Air Travel. Television. The Microprocessor, The Internet, etc. 

 

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.

 

 

Things are a bit different this time as they always are. Official overall CPI inflation numbers show tepid inflation. However, look at the charts below from official government data of the things that we all spend most of our money on: medical expenses, housing, food and energy. Not seasonally adjusted, Housing is up 48.3%, Medical Care is up 83.6%, Medical Services up 92%, Food up 48.6% and Energy is still up 67.2% (it was over 100% in 2014) since 2000. Real inflation that hits us all in the pocketbook and bank account is up anywhere from 50-100%, right in line with the post WWI and WWII inflation numbers on our 500+% move chart.

 

 

War still lingers, but it appears that major operations have come to a close. What remains is a war against an ideology that is being fought on multiple fronts. It will likely be costly, in human lives and dollars, and could persist for a great deal longer. Provided past success and current efforts remain effective we are most likely on the tail end of significant expenditures of capital, human and monetary.

 

We are not going to get wrapped up in the why or the how many were surprised by last week’s Presidential Election outcome. The bottom line is that a major shift has just occurred in D.C. The incoming administration campaigned to reduce regulation, cut taxes and generally get the Federal government out of the way of the economy, entrepreneurs and business. Infrastructure and national defense are also expected to receive major fiscal attention from the Federal government.

 

A lot of this is similar to the approach that the Reagan administration took. We know this time is different, Trump is not Reagan, but a big political shift has just occurred like when Reagan took office. When Reagan took office, the 10-year Treasury was in double-digit territory, today it’s just above 2%. Borrowing at 2% makes a lot more sense than 10% plus to fund infrastructure and defense spending. Stock valuations were much lower in 1980, but the demand for stocks was also much lower. The higher valuations of today are supported by sovereign wealth funds, private IRA’s, 401k’s, 529 plans, etc. The days of single-digit S&P 500 P/E are in all likelihood long gone. Even low double-digits may never be seen again.

 

Most of the ingredients are in place for the next Super Boom. The market has been stuck in a secular bear for approximately 16 years. Inflation has accelerated and major conflict is winding down. Numerous paradigm shifting technologies appear to be on the verge of making it into the mainstream. And the potential exists for the incoming administration to at least partly repair the dysfunction in D.C.

 

From here we see two possible scenarios. The first is our original expectation for a garden variety 20-30% bear market sometime in 2017-2018 that ultimately leads to the beginning of the next Super Boom. This scenario is most likely if the new administration fails to act quickly early next year. Any delay or even perceived delay in implementing major policy changes will lead to disappointment and could easily be the catalyst for a 20-30% bear market.

 

Our second scenario relies upon early and effective execution from the Trump administration. Given Trump’s tenacity, we would expect him to put forth significant effort early and quickly. With quick and at least partially successful action, the market could easily continue to rally towards a 500% gain from the 2009 lows. In this case the mini-bear from earlier this year would have been the markets reset point and a rally on the order of 70-90% from February’s low is likely before the next pause.

 

We expect the market will decide which scenario is in play rather quickly next year, possibly as early as April or May. In the meantime, the Best Six Months are underway and DJIA’s streak of seven consecutive days of gains is bullish.

 

Election Day has finally arrived and perhaps within a few more hours we will know the outcome. This time certainly has been different, but in many respects the market has performed similar to past presidential elections. The market was down in the two weeks prior to the election week. Historically the week before has a bullish bias while two weeks before it was bearish. The market was also up big yesterday, the day before, which has also been the trend since 1952. So what does history have to say about after the election?

 

In the following chart, November’s performance in “All Years” and Presidential “Election Years” over two time frames are compared. Over the more recent era, 1952 to 2012, November’s performance is very similar whether or not it is an election year. By the end of November S&P 500 has averaged right around 1.5%. Extending data back to 1930, S&P 500 performance in November does weaken, but the full-month remains positive.

 

 

Delving deeper into the data we examined S&P 500 performance on the day after Election Day, Election Week, from the close on the day after Election Day to November’s close and December’s close in the following table. The day after Election Day is solidly bearish regardless of timeframe with the S&P 500 posting average losses of 1.12% since 1932 and 0.78% since 1952. Full week performance is modestly bullish using 1932 to 2012 data, but noticeably weaker since 1952. From the close on the day after the Election until the end of November and December, S&P 500 performance is basically mixed, up only slightly more than 50% of the time, although it manages average gains of 0.66% and 1.80%, respectively, since 1952. Incumbent candidate and/or party victories are shaded in light grey. 

 

 

Political uncertainty should be resolved soon and no matter who claims the White House, Congress is likely to remain split and gridlock will probably continue. Provided economic data does not weaken substantially, the path higher for the market is available.  

 

 

No new sector trades begin in the month of November. Oil’s seasonal weak period that typically begins in September does come to an end at the start of November. There is no trade held in the portfolio associated with this seasonality to close out. The short trade was stopped out in September.

 

Since issuing our Seasonal MACD Buy Signal after the close on October 24, the market drifted steadily lower until yesterday. S&P 500 declined for nine straight days during that time. It was an orderly market retreat that offered ample opportunity to pick up “Best Six Months” related trade ideas at better prices. Weakness was most pronounced within Healthcare and Biotech sectors. iShares NASDAQ Biotech (IBB) was stopped out on November 3 when it closed below its stop loss. It has since rebounded with the broader market, but the specter of further regulation in the sector still remains and could be elevated further following the result of today’s election. SPDR Healthcare (XLV) is the second worst performer in the portfolio and it is on Hold.

 

iShares DJ US Telecom (IYZ) is the worst position, down 5.4% since addition. This sector, with its relatively stable revenues and dividends is likely under pressure from the potential of higher rates. IYZ is on Hold. CurrencyShares British Pound (FXB), SPDR Financial (XLF) and SPDR Gold (GLD) are also on Hold. FXB, XLF and GLD are also all susceptible to an interest rate hike. Higher rates could lead to a stronger U.S. dollar which could cause FXB and GLD to weaken. XLF could benefit from a steeper yield curve, but a short-term rate increase does not guarantee long-term rates will also rise. 

 

Core four positions in DIA, IWM, QQQ and SPY, used to trade our Tactical Seasonal Switching Strategy (Best Six/Eight Months), can be considered on dips below their respective buy limits or at current levels. All other positions not previously mentioned can also be considered on dips below their respective buy limits or at current levels. Please see table below for Buy Limits and Stop Losses. Please note that Current Advice is based upon closing prices from November 7. Positions may now trade above their buy limit.

 

 

 

Gold prices tend to move up prior to the holidays, and the trend has worked especially well over the last 16 years. Seasonally speaking, it is best for traders to go long on or about November 17 and hold until about December 2. Over the last 41 years, this trade has worked 22 times for a success rate of 53.7% .The cumulative profit tallies up to $25,220. Up until four years ago this trade had been profitable for 12 straight years (2000-2011). The longer-term history of this trade is not as good, nonetheless profitable. Gold has had a solid year, but this is a short-term trade and gold has become oversold and appears ready for a bounce. 

 

 

The chart below shows the correlation between gold and the exchange-traded fund SPDR Gold (GLD). This fund’s single holding is physical gold bullion. GLD currently holds 945.26 tons of gold giving it a market valuation of approximately $39.5 billion. GLD’s price line has been overlaid on the front-month gold futures contract. The line on the bottom section is the 41-year average seasonal price move for gold with the yellow shading highlighting seasonal strength from mid-November to mid-February. This trade targets the beginning of this seasonal move that typically peaks the first week of December.

 

 

In the next chart, GLD is plotted above its stochastic, relative strength and MACD indicators. All three of these indicators are positive and near overbought levels. GLD is attractive at on dips with a buy limit of $122.75. GLD is already held in the ETF Portfolio and we will add to the existing position should GLD trade below its buy limit.

 

 

 

Typically, we see a seasonal tendency for 30-year Treasury bond prices to peak in mid-November to mid-December and then start a decline lasting into April (highlighted with yellow box below). Perhaps investors seeking a higher return feel more comfortable buying into the year-end stock market rally, so they sell bonds and reallocate funds into equities. Or perhaps end-of-year window dressing or savvy traders, wishing to take part in the up-coming January effect, play a role in the decline of bond prices.

 

 

This trade in the last 39 years has just a 48.7% success rate. Considering the bond market has been in a secular bull market for over three decades, this short trade has fared reasonably well. The trade’s shorter-term record is even weaker with seven losses and just two wins since 2007. Losses in 2007 and 2008 were the result of recession and financial crisis. In 2011 and 2012, the Fed took action to drive longer-term interest rates lower (bond prices higher) and Europe’s debt crisis triggered a flight to safety as well. In 2013, 2014 and 2015 tepid global growth and signs of deflation strengthened demand. Now the Fed’s next move appears to be another interest rate increase. Even though the Fed will only be directly changing the Fed Funds rate, higher short-term interest rates usually translate into higher long-term rates and lower bond prices for existing supply.

 

 

Traders may consider shorting the exchange-traded fund iShares Barclays 20+ Year Bond (TLT) or trading its put options as a replacement for the futures contract. TLT recently broke down through support at its 50- and 200-day moving averages and is just above projected monthly support (green dashed line) at $128.28. Stochastic, relative strength and MACD indicators are all negative. TLT could be shorted near resistance at $133.03 or on a break down below $128. If shorted, set a stop loss at $136. This trade will also be tracked in the Almanac Investor ETF Portfolio.

 

 

[Editor’s Note: Please register for Jeff’s Webinar, 50 Years of Election Handicapping, Plus How to Deploy Tactical Seasonal Sector Rotation & Stock Trading Strategies scheduled for Thursday Nov 3, 2016 at 1:00 PM EDT at: https://attendee.gotowebinar.com/register/8455546062137936642.  

Celebrating the 50th Anniversary Edition, of Stock Trader’s Almanac 2017, Jeff looks at the impact of the upcoming Presidential Election on the market today, and how to position yourself for Q4 2016 and beyond. The Election Cycle sets up poorly for 2017-2018. Jeff expects a bear market could take the market 20-30% lower into 2017-2018. Then his 2010 Super Boom forecast kicks in, pushing the Dow to 38,820 by 2025. Learn sector rotation, long and short, using fundamentals, technicals, seasonality, cyclical trading strategies, economic trends, and historical patterns pinpointing high-probability setups for stocks and ETFs.]

 

October did live up to its reputation of being weak in Election years. For S&P 500 October’s 1.9% decline was its second worst monthly performance this year and it was also the third consecutive down month. DJIA has also declined in three straight months. NASDAQ and Russell 2000 suffered the most damage in October, off 2.3% and 4.8% respectively. October’s poor performance in presidential election years has historically been accompanied by an incumbent party loss since 1952 (see page 28 of Stock Trader’s Almanac 2016). In the following chart the 30 trading days before and 60 trading days after the last 16 presidential elections are plotted.

 

 

In the above chart, Election Day is Day 0. Prior to 1984, the market was closed on Presidential Election Days so the close on the day before was used. Since 1984, the close of trading on Election Day was used. Day 26, to the left of “0” was the first trading day of October in 2016. As of today’s close, S&P 500 is suggesting an Incumbent party defeat. It is also noteworthy to observe weakness across all three lines between 10 to 5 Trading days before Election Day and then a rally from right around 5 Trading days before to Election Day.

 

But the majority of polls still show Democrat Hillary Clinton besting Republican Donald Trump a week from today. This still holds true today even after the FBI announced it may have further information to review and consider regarding Hillary Clinton’s use of a personal email server. Perhaps, the market is actually less concerned about the election and more concerned about the Fed. Economic data has been improving and the labor market has remained firm. The initial estimate for Q3 GDP came in at a consensus beating 2.9%. Unemployment is 5% while monthly job gains have been solid. Inflation may still be below target, but it appears to be trending higher. Data firming, inflation trending in the correct direction and a Fed that seems eager to raise rates does add up to a high probability of a rate increase in December.

 

Further evidence of a pending rate hike can be found by examining the U.S. dollar index. It briefly touched 99 last Thursday, its highest level since January. The prospect of higher rates has also put pressure on bonds with Treasury bond rates steadily moving higher throughout October. Interest rate sensitive sectors of the market have also been behaving like a rate increase is coming. Financials improved in October while Utilities, Telecom and REITS declined. The market’s recent behavior seems more consistent with positioning for a rate increase within the context of a “different” Presidential race. 

 

Once Election Day passes, political uncertainty should subside and no matter who claims the White House, Congress will most likely remain split resulting in at least two more years of gridlock. The end of political uncertainty is also coinciding with the market’s strong historical tendency to rebound briskly following three straight down months. Coupled with the start of the market’s “Best Six Month”, November to April, there is a strong case to remain committed to being long per our Tactical Seasonal Switching strategy.

 

 

However, the Three Peaks and a Domed House Top Pattern we have been tracking since the beginning of summer suggests an inauspicious future for the market. That’s not to say it’s a foregone conclusion that the market has topped out and will playout in textbook fashion with George Lindsay’s Basic Model shown below. 

 

 

 

This current Three Peaks lines up quite well with Lindsay’s Basic Model. The Three Peaks section lasted just 8 months from Peak 1 (point 3) in February/March 2015 to Peak 3 (point 7) in October/November 2015, falling right in the 8-10 timespan of the Model.

 

The Domed House top time frame in the Basic Model is about 7 months from the end of the Separating Decline at point 14 to the top at point 23. From the Separating Decline low in February 2016 that would have put the top sometime around or after September. But the current mid-August top is not out of line with historical examples of this pattern. We have seen this phase of the pattern transpire in much shorter and longer time frames.

 

After the Domed House Top, the pattern resolves at point 28, somewhere back around points 10 and 14 at a minimum. It can go substantially lower before a new high, which could culminate in a bear market. On the flipside, the more likely scenario at present with market, political and economic conditions as they are mentioned above, is that this pattern can still play out in its entirety, while the market rallies after the election through yearend and the Best Six Months. 

 

Even if it does complete at just the minimum level the approximate 15% drop would not be a bear market. It’s just something we have our eye on and wanted to be sure all Almanac Investors and Traders were aware of the risk suggested by this pattern.

 

Point 27 has also been recorded in the past at higher levels than point 23 and has taken several months to play out. As the economy firms up and the election is over we expect seasonality to take over and drive stocks higher, but next year is another story all together. 

 

As the Fed begins to tighten and rates rise and the new president completes their first 100 days look for the market to soften further as post-election year forces get stronger and the Best Six Months comes to an end in April.  At which point we may find ourselves entering bear market territory. For now, after three down months in a row, we expect a rebound.