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The Week Ahead: How High Can The Market Forecasts Go?

Posted by on Dec 17, 2016

The Week Ahead:  How High Can The Market Forecasts Go?

The one-day market decline on the long awaited Fed rate hike was well supported even though the potential plan for three hikes in 2017 rattled a few investors.  The market bulls are still clearly in charge with the financial media beating the drums with a fervor that has not been seen in some time.

Even though there is no reason to doubt the market’s rally right now anytime the financial press chants “no reason to sell” I do get nervous. Typically it would take a 3-5 day decline to change the tune of the headline driven financial press but without a correction the bullish commentary still dominates.

Clearly the market sentiment has seen a dramatic shift.  In my column published last August “What’s Missing From This Bull Market?”  I focused on the fact that throughout the bull market there had not been a period of investor euphoria. This goes back to the famous quote from legendary investor John Templeton that bull markets “die on euphoria.”

The psychology of a market cycle is nicely illustrated in the chart above and typically the euphoric phase is accompanied by greater individual participation in the stock market. The most recent data suggests that a large percentage is still not invested in stocks but the interest has clearly increased.

According to AAII the most recent survey of individual investors 44.7% are now bullish but only 23% were bullish before the election.  The bearish % stands at 32.3% and is well above the extreme low in the 20% area.  The professionals have also become much less bearish as the very high cash levels have dropped significantly in the past month.

It should be no surprise that the forecasts from the major Wall Street strategists have seen a major turn. Seasoned investors but not all columnists realize that these forecasts often go through dramtic changes during the year.

Frankly these forecasts do not play any role in my outlook and I often use them as a contrary indicator. In August I commented that “The new high in the major averages and leading action of the advance/decline lines has still not convinced everyone of the positive market outlook as Goldman Sachs advised their clients on August 1st to “avoid all stocks for the next three months”. They are also sticking with their year-end target for the S&P 500 at 2100 which is 3.7% below current levels.”

This table from the Wall Street Journal  reveals their forecasts for 2017 and the high end at 2400 for the S&P 500 would imply just a 6.6% rise from current levels. If you want to learn more about the accuracy of their forecast I would suggest you read this excellent New York Times article by Jeff Sommer.  In reviewing the strategist’s forecasts he quotes independent statistician Salil Mehta “It’s not easy to be as bad as they are.”

The post election rally is not unprecedented as the Wall Street Journal pointed out (Stocks’ Biggest Postelection Rally Ever) there have been “five other instances in which the Dow jumped at least 5% in a five-week period following a presidential election.”

The most recent example occurred in 1996 as the Dow Industrials rallied from 6081 on November 5th to a high of 6606 on November 26th which was a gain of 8.6%. This was followed by a fourteen-day correction of 6% before the Dow again turned higher.

By March 1997 the Dow had reached a high of 7158 which was a gain of 17.7% since the election.  After dropping 11.7% in the next five weeks the Dow bottomed in April before rallying another 32% before it topped in August. From the close on Election Day to the close on August 6, 1997 the Dow rallied 35.8%.

It should be pointed out that in September 1997 the Dow had already broken out of an eight-month trading range, lines a and b. The upside target from this trading range was at 6600 which was exceeded in January.

As the Dow approaches 20,000 there have been some articles discussing upside targets for the Dow at 40,000. This view was promoted in 2000 in books by Harry Dent and David Elias as both suggested the Dow could go that high. Harry is known for his outside the box forecasts as he has incorrectly forecast several dramatic rallies and declines since 2000 in his many very popular books.

On CNBC last week, as well as on many other platforms, John Spallanzani from GFI discussed why the Dow could hit 40,000 in the next five years.  It is the Republican control of both Congress and the Presidency that leads to this bullish forecast as the Dow is expected to gain 15% a year until it reaches 40,000.

The more important question for investors is whether they can benefit from these long-term forecasts?  I would argue that they do more harm than good as I have found that too many investors and traders focus on the potential reward of every investment and not the risk.

Also the poor performance of hedge funds has reinforced my long held view that for most individuals basing your investment on a macro view of the global economy and markets is not a good idea. It is also the reason that I do not support those who want to force the Federal Reserve to stick to a pre-determined economic plan as opposed to adapting to the economy the Fed  is facing. Each recession and economic recovery are different and cannot be defined by set rules.

Investors and even traders should concentrate on determining whether the economy is expanding or contracting as well as whether the S&P 500 is in a bull or bear market.  As long as the economy is expanding and stocks are in a bull market investors should be in the stock market.

Since the spring of 2009 my stock market outlook has remained positive as my unique analysis of the advance/decline data has shown no negative signs as it did in 2007.  During the same period my analysis of the economy has never indicated that we have dropped back into a recession. As many may recall in in 2010 and 2011 there were periods when many felt that a recession was inevitable.

In terms of price targets I only discuss price targets that are based on the charts or technical analysis.  The current weekly chart of the Dow Industrials shows that the trading range, lines b and c, was completed in July.  Using the width of this trading range one obtains an upside target for the Dow at 21,332, line a.

The similar trading range in the S&P 500, lines c and d, has upside targets at 2456. This is 8.5% above Friday’s close which is not an unreasonable target in 2017.  The longer-term monthly chart shows the eighteen year trading range (lines a and b) that was completed in May 2013, point 1.

When there is an increase in bearish sentiment, as there was last summer, I have told investors to focus on the bullish nature of this breakout. The upper boundary of this range was 1576 and the lower end was at 666. Therefore the width of the formation was 910 points. This added to the breakout level of 1576 results in an upside target for the S&P 500 at 2486. It is likely significant that these two target levels derived from two different ranges are so close together.

The iShares Russell 2000 (IWM) is up 17.6% since the election as the markets are convinced that the small cap stocks will benefit the most from the Trump presidency.  The monthly chart shows that a broad trading range, lines b and c, developed in 2015 and 2016.

The November close at $131.61 completed the trading range and Viper ETF traders bought on December 5th at $131.95. The completion of the monthly range has long-term targets at $159.91, line a, which is over 17% above current levels.

The monthly Russell A/D line broke through its resistance, line d, last summer. The A/D line made a new high in November and is on pace to make another new high in December. The weekly and daily A/D lines are also in solid up trends and show not clear signs yet of even a short-term top.

This analysis does not mean the Dow will not reach 40,000 but if it does there should be meaningful corrections along the way.  This chart from dshort.com  shows the eight meaningful corrections since the bear market low in 2009. During the market euphoria that occurred from the 1996 election until March 2000 high there were a number of market corrections including the 22% drop in 1998.

It will be important for investors to use technical analysis including relative performance and on-balance-volume (OBV) to target those ETFs and stocks that are leading the market higher. Over the past few weeks there has been a rotation into sectors that had been lagging the market.

The Economy

There was a flood of economic data on Wednesday along with the FOMC announcement.  The headline Retail Sales number came in below expectations at 0.1% as a drop in auto sales had a big impact. Industrial Production and Business Inventories were also lower than the consensus estimates.

The Philadelphia Fed Survey came in strong at 21.5 which was well above the consensus estimate of 10.  The chart had formed higher lows over the past year, line a, prior to the recent surge. In the report “Manufacturers were much more optimistic about growth over the next six months.” The Empire State Manufacturing Survey was also strong and the flash PMI Manufacturing Index increased over the past month.

Builders are also quite bullish despite the increase in mortgage rates as the Housing Market Index rose to 70 from 63 the prior month.  The volatile Housing Starts Friday dropped 18.7% in November but this is typically a wide-ranging data series.

On Monday we get the flash reading on PMI Services followed on Wednesday by the Existing Home Sales Index. The main data is on Thursday with Durable Goods, GDP, the Chicago Fed National Activity Index and Leading Indicators. Friday we have the New Home Sales and Consumer Sentiment reports.

Interest Rates & Commodities

The yield on the 10 Year T-Note continued to surge last week, closing at 2.597%. The next widely watched target is in the 3.00% area.  Bonds are very oversold and the rise in yields has stretched the rubber band tight.

Crude oil closed higher but off Monday’s highs. The HPI did make a new high for the year. While several CNBC pundits say crude oil can’t overcome the $56 level the technical outlook suggest it can. Anytime someone in the financial media uses never or always I become skeptical.

Gold was crushed in reaction to the stronger dollar and looks ready to test the late 2015 lows.

Market Wrap

The major averages made their highs Tuesday but most other than the Dow Industrials closed the week lower.  The Dow Transports, which had led the market higher, closed down 2.5% followed by a 1.7% drop in the Russell 2000. The S&P 500 was down a fraction while the Dow Utilities were up 1.8%.  For the first time in many weeks the declining stocks led the advancing ones by a 2-1 margin.

The weekly chart of the Spyder Trust (SPY) shows that a doji was formed last week. The doji low was $224.05 so a close this Friday below this level will trigger a doji sell signal. The chart shows a well-defined trading channel, lines a and b, as the SPY came close to the weekly starc+ band last week. It now stands at $228.94.

There is minor support now at 222.84 and the rising 20-day EMA with more important in the $220.50-$221 area. The 38.2% Fibonacci retracement support from the November 4th low is at $219.38.  The weekly S&P 500 A/D line has turned lower but is well above its now rising WMA. There is major support at line c, which was former resistance.

The NYSE Composite came close to the 2015 high at 11,254 (line a) before it turned lower. The 20 day EMA and lower starc- band are now in the 11,000 area with further support at 11,908 which is 2% before Friday’s close.

The NYSE A/D line pulled back to its WMA on Wednesday before it turned higher.  A drop below the WMA and the support at line c would make a more complex correction likely. A convincing drop below the early December lows would be a sign of more weakness. The weekly A/D line did make a new high with the close on 12/9.

What to do?   The lower close last week increases the odds that we will see an overdue pullback. Many of the averages do not have to drop much before they reach good support.  I would expect that even if there is not much of a pullback the sector rotation will occur.

There are a number of ETFs that have not participated in the post-election rally and they are now closer to more important support. Several of the more defensive sectors bottomed a few weeks ago and did perform well this week.

Those who are not in the market should start a dollar cost averaging program is the market continues to correct or starts to move sideways. Look for a well-diversified ETF that has a low expense ratio.

Viper ETF clients are long a number of different sector ETFs and have open orders to by several on a further pullback before the end of the year.

The Viper Hot Stocks Report recommends both long and short stock positions based on the weekly scans as well as the monthly indicators. There were an equal number of new buy and sell signals after last week which will be examined for new recommendations.

Each service is only $34.95 per month and includes regular trading lessons as well as the twice a week reports. New subscribers receive four of the most recent trading lessons and subscriptions can be cancelled anytime online.