October 2017 Trading & Investment Strategy By: | September 28, 2017 | Email | Print

9/27/2017: Dow 22340.71 | S&P 2507.04 | NASDAQ 6453.26 | Russell 2K 1484.81 | NYSE 12157.65 | Value Line Arith 5758.54

 

Psychological: Relieved. According to the most recent Investors Intelligence Advisors Sentiment survey bulls jumped to 54.3%, bears are at 17.1% and correction is at 28.6%. This marks a reversal in trend of more bears and correction that occurred throughout August into September. The market may have successfully navigated the worst two consecutive month stretch of the year, August-September, based upon historical performance, but October still lies ahead. VIX declining back below 10 warrants attention as the string of closes under this level in July preceded a brief bout of market weakness.

 

Fundamental: Stalled. Final Q2 GDP came in at a revised higher 3.1%, the best reading since Q1 of 2015, but Q3 and beyond is not expected to be as strong. Atlanta Fed’s GDPNow model is forecasting 2.1% growth in the current quarter. Unemployment has also likely bottomed, having switching between 4.4% and 4.3% since April. Corporate earnings forecasts for Q3 have also been trimmed. 

 

Technical: Mixed. Small-cap Russell 2000 index has broken out to new all-time highs after spending much of the year lagging. DJIA, S&P 500 and NASDAQ all closed at new all-time highs in September, but have been struggling to maintain that momentum and move higher since. Although right on the verge of a unified move higher into record territory, the major indices still have not been successful. Looking back to previous jumps higher this year, such as late February to March 1 and early July through early August, this recent surge higher could be followed by a period of sideways to lower trading and a better buying opportunity than now.

 

Monetary: 1.00-1.25%. Employment and growth are acceptable, but inflation (measured by Fed’s choice of metrics, PCE) remains stubbornly below target. The Fed’s next move of rates could be December at the earliest. In the meantime, the Fed will begin to shrink its balance sheet in October. It will begin by not rolling over the first $6 billion in maturing Treasury securities and $4 billion of agency debt and mortgage-backed securities. Simply put they will begin taking liquidity out of the financial system at a pace of $10 billion per month to begin with. This liquidity was at least partially responsible for supporting the market since its March 2009 bear market low.

 

Seasonal: Improving. October is the last month of the “Worst Six Months” for DJIA and S&P 500 and the last month of NASDAQ’s “Worst Four Months”. In post-election years, DJIA has been up 11 times in 17 years with an average gain of 0.7%, but in the last three years ending in “7,” October has been trouble. In 2007, the bull ended and the financial crisis began, in 1997 DJIA plunged 12.4% and in 1987 the market crashed. Keep an eye out for our Seasonal MACD Buy Signal email Alert. It can trigger anytime on or after October 2.

 

A big upside move of over a 5% gain on the S&P 500 during the Worst Six Months (or the “Sell in May” period) from May through October has been followed by great gains for both frequency and magnitude. There is just one month left in the Worst Six Months. So if the market can log further gains in October and not succumb to often self-fulfilling prophecy of Octoberphobia and the curse of the 7th year that would be a solid indication for stronger gains over the next Best Six Months (November to April) and 2018.

 

We currently sit at +5.3% for the S&P 500 since the close of April 2017. Not bad, but not great, and right on the cusp of the level of Worst-Six-Months gains the have been more often followed by big upside moves. Look at the three tables below of “Not Bad”, “Great” and “Bad” Worst Six Months. Bad and Great were both followed by better Best Six Months returns than the Not Bad years. 

 

Also for perspective we have included performance for the full year and the next year. Bad WSM usually accompany down years, but better following years. Great WSM have been part of up years 100% of the time and decent following years, while Not Bad WSM has occurred in better years but weaker following years. 

 

 

 

If the market can digest the Fed’s $10 billion monthly liquidity reduction in the financial system that begins next month and log gains in October, we should expect a solid Best Six Months. But if Octoberphobia strikes in the 7th year again, like it did in 2007, 1997 and 1987 than we would expect a softer BSM and 2018.

 

As you can see in the charts below of NASDAQ and S&P 500 our MACD indicators are currently not in prime Buy Signal position: above the zero line and on the verge of breaking down. Any October correction would set up or Buy Signal quite nicely. Developing…

 

 

 

After bouncing around its 50-day moving average in late-August and early September, DJIA briefly broke out to new all-time highs (1) in a 9-day winning streak. Like previous consecutive daily winning streaks, that streak came to an end on September 21. Three trading days later, DJIA’s faster moving MACD “Buy” indicator (2) turned negative confirming a loss of upward momentum. DJIA’s slower moving MACD “Sell” indicator has not yet turned negative.

 

 

Over the last 18 weeks through the week ending September 22, DJIA has advanced 13 times (3) adding a cumulative 1544.75 points. These consistent yet modest gains have shored up investor and trader confidence with more than a third of these gains coming from Fridays. DJIA did suffer a Down Friday/Down Monday (DF/DM) earlier this week (4), but like other occurrences this year, a significant selloff has not materialized yet and may not.

 

S&P 500 and NASDAQ have not been as strong as DJIA over the past 18 weeks. S&P 500 has recorded losses in six weeks (5) while NASDAQ has been down nine times (6). Even though S&P 500 and NASDAQ weekly track record has been softer than DJIA, they have joined the new all-time high party this September.

 

NYSE Weekly Advancers and Decliners (7) have been in line with the market’s overall performance in recent weeks. Modest weekly gains have been accompanied by Advancers modestly outnumbering Decliners. During down weeks the opposite has held. Absent any extreme readings, the market will likely remain somewhat dull absent volatility.

 

NYSE Weekly New Highs (8) reversed course at the end of August and had been gaining each week until last. NYSE Weekly New Lows were also declining until last week. The trend of more highs and fewer lows need to remain intact for the rally to persist. Should New Weekly Lows expand further this week, then another modest market retreat is possible.

 

The spread between the 90-day Treasury Rate and the 30-Year Treasury Rate (9) appears to have bottomed during the second week of September. During the week ending September 8 the spread was as narrow as 1.66. That was the smallest difference since January 2008.

 

 

 

But October has also been a turnaround month—a “bear killer”. Twelve post-WWII bear markets have ended in October: 1946, 1957, 1960, 1962, 1966, 1974, 1987, 1990, 1998, 2001, 2002 and 2011 (S&P 500 declined 19.4%). However, eight were midterm bottoms. This year is neither a midterm year nor is a bear market in progress, thus October’s performance in past post-election years is of greater importance.

 

Post-election year October’s are neither great nor bad since 1953, ranking mid-pack across DJIA, S&P 500, NASDAQ and Russell 1000 with gains averaging from 0.7% (DJIA) to 1.2% (NASDAQ). DJIA has the best historical odds for gains having advanced in 11 of the last 16 post-election year Octobers. Despite the best average gain, NASDAQ actually has the worst record, declining in 6 of the last 11 post-election year Octobers. A 12.8% gain in 2001 boosts its average. Should a meaningful decline materialize in October it is likely to be an excellent buying opportunity, especially for any depressed technology and small-cap shares.

 

 

Options expiration week in October provides plenty of opportunity. On the Monday before expiration the DJIA has only been down eight times since 1980 and the Russell 2000 is up twenty of the last twenty-seven years, seventeen straight from 1990 to 2006. Expiration day has a spotty record as does the week as a whole. After a market bottom in October, the week after is most bullish, otherwise it is susceptible to downdrafts.

 

October is also the end of the Dow and S&P 500 “Worst 6 Months” and NASDAQ “Worst 4 Months”. Remain on the alert for our Seasonal MACD Buy Signal that can occur anytime beginning October 1. An email Alert will be sent when it triggers. At that time we will likely establish new long positions in SPDR DJIA (DIA), SPDR S&P 500 (SPY), PowerShares QQQ (QQQ) and iShares Russell 2000 (IWM) and we may also pickup any remaining open recommendations from the ETF Portfolio. We will also close out defensive positions and cover any outstanding short trades.

 

Let’s step out on another limb today and just go ahead and declare the Los Angeles Dodgers this year’s World Series Champs. Never mind completing the balance of regular season games or playoffs, they have the best record in all of MLB today. Congratulations LA Dodgers, 2017 World Champs!!! This is exactly what is happening today with the market. New all-time highs in September (and August) apparently automatically mean that Selling in May failed this year and the market can only go one direction from here. Let’s not forget its September 14, 2017 and the Worst Four/Six Months don’t actually end until November 1. That’s over six weeks from now and those six weeks are riddled with some nasty sell offs throughout history.

 

 

In the above chart, we can see DJIA, S&P 500, NASDAQ and Russell 2000 rallying off their respective mid-August lows in the top pane and solid support by Advance/Decline lines in the lower panes. But, note how quickly things have changed in the past. A late-July peak in A/D lines and subsequent pullback was accompanied by a similar move in the major indexes. And from their respective May 2017 closes through yesterday’s close DJIA is up 5.5%, S&P 500 3.6%, NASDAQ 4.2% and Russell 2000 is up 4.1%. It would only take a few 1 percent daily losses to wipe out those gains. The next six plus weeks have a history of that and often much more.

 

 

First off, next week is the week after September options expiration week and it has a dreadful history of declines particularly since 1990. This week has been a nearly constant source of pain with only a few meaningful exceptions over the past 27 years (shaded in grey). Substantial and across the board gains have occurred just four times: 1998, 2002, 2010 and 2016 while many more weeks were hit with sizable losses.

 

 

 

Since 1990, average weekly losses are even worse; DJIA –1.07%, S&P 500 –1.00%, NASDAQ –0.98% and a stout –1.50% for Russell 2000. End-of-Q3 portfolio restructuring is the most likely explanation for this trend as managers trim summer losers and reposition portfolios for the upcoming fourth quarter.

 

 

Then some of you may remember the old saying on the Street, “Buy Rosh Hashanah, Sell Yom Kippur.” Though it had a good record at one time, it stopped working in the middle of the last century. It still gets tossed around every autumn when the “high holidays” are on the minds of traders as many of their Jewish colleagues take off to observe the Jewish New Year and Day of Atonement. 

 

The basis for the new pattern is that with many traders and investors busy with religious observance and family, positions are closed out and volume fades creating a buying vacuum. Holiday seasonality around official market holidays is something we pay close attention to (page 88 Stock Trader’s Almanac). Actual stats on the most observed Hebrew holidays have been compiled in the table here.

 

 

We present the data back to 1971 and when the holiday falls on a weekend the prior market close is used. It’s no coincidence that Rosh Hashanah and Yom Kippur fall in September and/or October, two dangerous and sometimes opportune months. We then took it a step further and calculated the return from Yom Kippur to Passover, which conveniently occurs in March or April, right near the end of our “Best Six Months” Tactical Switching strategy.

 

Perhaps it’s Talmudic wisdom but, selling stocks before the eight-day span of the high holidays has avoided many declines, especially during uncertain times. While being long Yom Kippur to Passover has produced more than twice as many advances, averaging gains of 7.2%. It often pays to be a contrarian when old bromides are tossed around, buying instead of selling Yom Kippur – and selling Passover. This year the high holidays commence on September 21, in the middle of the week after September options expiration.

 

 

October has a frightful history of market crashes such as in 1929, 1987, the 554-point drop on October 27, 1997, back-to-back massacres in 1978 and 1979, Friday the 13th in 1989 and the 733-point drop on October 15, 2008. During the week ending October 10, 2008, Dow lost 1,874.19 points (18.2%), the worst weekly decline in our database going back to 1901, in point and percentage terms. Absent a bear market in progress, October’s historical tendency for bear market bottoms is a moot point. October’s record in years ending in seven is of concern. October 2007 was a bull market high, in October 1997 DJIA plunged 12.4% from October 7 to October 27 and during the crash of October 1987 DJIA tanked 23% in two days.

 

Keeping all of this mind and recognizing that more than six weeks remain before the “Best Six/Eight Months” of the year actually begin on November 1 it is far too early to sound “all clear.” We will continue to maintain a defensive posture in the Almanac Investor Portfolios. We will also look forward to enjoying the remainder of the baseball season and playoffs.

 

 

Over the past month since last update, S&P 500 climbed 1.2% higher while Russell 2000 jumped 3.1% higher as of yesterday’s close. The Almanac Investor Stock Portfolio’s blend of cash, long and short positions slipped 0.8% over the same time period excluding dividends and any trading costs. Our Large-Cap portfolio performed best, up 1.8%. Small-Caps edged 0.4% lower while Mid-Caps shed the most, off 3.6%.

 

Of the seven positions held in the Small-Cap portfolio just two made any meaningful progress, Global Brass and Copper Holdings (BRSS) and the short position in PDF Solutions (PDFS). Modest gains here were in sufficient to offset the losses by the rest of the Small-Caps. Century Communities (CCS) was the worst performer and was stopped out on August 30. All positions in the Small-Cap portfolio are on Hold.

 

Worst overall Mid-Cap performance was spread fairly evenly across the portfolio as all long positions slipped lower and short positions struggled. Bluepoint Med (BPMC) was covered when it closed above its stop loss on August 23. Halozyme Therapeutics (HALO) was also covered on September 8 when it closed at its stop loss. A modest 7.8% gain was recorded on the BPMC position while HALO was covered for a 3.5% loss. All mid-cap positions are on Hold.

 

Large-caps continue to dominate. UnitedHealth (UNH) and Arista Networks (ANET) both continued to move higher over the past month. The Hershey Company (HSY) also climbed higher and is once again trading back above its original purchase price. UNH, ANET and HSY are all on Hold. Due to recent gains, stop losses for UNH and ANET have also been raised further.

 

Of the four large-cap short trade ideas three are profitable. Mattel Inc (MAT) and Mosaic (MOS) are working well, both showing double digit gains. Sealed Air Corp (SEE) has reversed course and is headed lower undoing last month’s 3.1% loss for a 1.6% gain at yesterday’s close. Tesla Inc (TSLA) is the only blemish in the Large-Cap portfolio, but we are willing to stick with it. Broader weakness in the auto sector seen in monthly sales figures could hit TSLA even harder as they serve a narrow segment of the entire market. News of additional chargers and more spending on a semi-truck may lift shares today, but will only burn more cash. TSLA short trade is on Hold. 

 

All other positions, not mentioned above, are currently on Hold. Please refer to the updated portfolio table below for Current Advice about each specific position. Please note that many stop losses have been updated.

 

 

 

Seasonally speaking, crude oil tends to make significant price gains in the summer, as vacationers and the annual trek of students returning to college in August creates increased demand for unleaded gasoline. The market can also price in a premium for supply disruptions due to threats of hurricanes in the Gulf of Mexico. However, towards mid-September, we often see a seasonal tendency for prices to peak out, as the driving and hurricane seasons begin to wind down. Crude oil’s seasonal decline is highlighted in yellow in the following chart.

 

 

Shorting the February crude oil futures contract in mid-September and holding until on or about December 10 has produced 22 winning trades in the last 34 years. This gives the trade a 64.7% success rate and theoretical total gains of $101,920 per futures contract. Following three consecutive years of losses, this trade has been successful in four of the last five years. 

 

 

It has been over three years since crude last traded above $100 per barrel. Ample supply and inventories have largely keep price under $50 per barrel ever since. Even hurricane Harvey had just a modest impact on crude’s price. Gasoline did spike, but crude did not. Crude’s failure to respond suggests it next move could easily be lower especially as summer driving season demand begins to fade.

 

 

ProShares UltraShort Bloomberg Crude Oil (SCO) is the preferred vehicle to take advantage of seasonal weakness. SCO’s benchmark is the Bloomberg WTI Crude Oil Sub index which is comprised entirely of crude oil futures contracts. SCO is designed to return 200% of the inverse of the daily move of this index and has nearly $200 million in assets. Its expense ratio of 0.95% is about average for a leveraged, inverse ETF.

 

Crude oil’s recent bounce has caused a corresponding drop in SCO. As a result, stochastic, relative strength and MACD Buy indicators are all negative. SCO could be bought on dips below $36.50 with corresponding signs of improvement by technical indicators. SCO will be tracked in the Almanac Investor ETF Portfolio. If purchased, an initial stop loss at $32.95 is suggested.

 

 

Over the past month since last update, we have seen the “wall of worry” grow even higher and the market has drifted modestly lower. This is nearly a textbook seasonal scenario setting up. During the past five weeks defensive positions taken as part of our Tactical Seasonal Switching Strategy have improved notably. iShares 20+ Year Bond (TLT) is now up 3.6%, iShares Core US Aggregate Bond (AGG) is up 1%, iShares Silver (SLV) is up 5.0% and SPDR Gold (GLD) is up 6.1%. Other defensive positions in XLP, XLV and XLU are also performing well. These positions are all on Hold.

 

Short trades in SPDR Materials (XLB), iShares DJ Transports (IYT) and SPDR Financials (XLF) are still underwater. XLF has weakened recently and could soon turn profitable. XLB and IYT are little changed over the past month. Continue to Hold short positions in XLB, IYT and XLF.

 

Seasonal weakness in natural gas companies has come to an end. Cover the First Trust Natural Gas (FCG) short position. For tracking purposes, FCG will be closed out of the portfolio using its average trading price tomorrow.

 

iPath Bloomberg Livestock (COW) and PowerShares DB Agriculture (DBA) were both stopped out in mid-August. COW and DBA were closed out using the average trading price on the day after they closed below their respective stops.

 

CurrencyShares Swiss Franc (FXF) and SPDR Energy (XLE) trades were executed just prior to mid-August. FXF was added when it briefly traded below its buy limit on August 8. XLE was shorted when it broke down through support. FXF is modestly higher now while XLE has bounced and is now in the red. FXF and XLE are on Hold.

 

All other positions not mentioned above are currently on Hold. Please see table below for current advice and stop losses.