The post-election rally is firmly on track, closely following the spaghetti model I showed in April. Predictions are prone to failure, and it is certainly a very big if, but if the market continues to track this model, it works out to a year-end target for the $SPX of 2663. Can we get there? As usual, the market has us on the horns of a dilemma.
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Post-Election Rally Stays on Average Track
Now that the fourth quarter is here, which is usually bullish, even with all the volatility of October thrown in, I thought it was a good time to review the post-election rally "spaghetti model" that I first discussed in April, and last updated in July. The SPX is barrelling along the average line in Chart 1, and if it continues to do so for the rest of the year, then the year-end target works out to 2663. But, can we get there? I gave a few reasons why this rally could continue two weeks ago. I will add a few more hopeful signs to that discussion today.
Chart 1: The post-election rally continues to hug the average of the seven presidential terms identified in the chart. If, and it is always a big if, the market continues to follow the average, then that projects to a year-end close of 2663. Of course, a close at 2429, at the lower dashed line, would also be consistent with the model.
Trend Check Carpet is Mostly Green (Except for the QQQ)
Other than the weakness in technology stocks in the short-term, the trends are bullish across all time frames and key market indexes. The market index breadth increases from 30-stocks in the Dow to over 2000 stocks in the NYSE Composite... and thus the market is trending higher very broadly. (My trend-following models are discussed here.) The up-trend this year has remained steadfastly long in the intermediate- and long-term, even as choppiness has been visible in the short-to-medium term periods.
Chart 2: Except for the QQQ in the short-term, all the major market indexes are trending higher across all time frames. Time step doubles from top to bottom from 25 to 200 days. The number of stocks in each index increases from left to right, from 30 to over 2000.
Small Stocks and Financials Have Made New Highs
A weakness in small stocks led the market lower. Now however, small stocks have made a rapid recovery as I also discussed recently. I begin by showing the absolute returns of the S&P Small Cap Index ($SML) versus other key indexes and index-based ETFs (see Chart 3). Clearly, as has been referenced elsewhere on the site, there has been some money coming out of technology stocks and rotating into Small Cap stocks.
Chart 3: In September, small caps ($SML) have outperformed large caps ($SPX) and tech stocks (QQQ). The financials-laded VTWO Russell 2000 ETF has outperformed the Russell 1000 ETF (VONE). Even Mid Cap stocks have caught a bid ($MID).
Chart 4: After moving sideways for 9 months, $SML finally broke out firmly to the up-side. Perhaps this will mimic the post-election surge. I have used this chart before.
Chart 5: Financials, which dominate the Russell 2000 Index (VTWO ETF) finally seem to have awoken from their seven month slumber.
Chart 6: VTWO, the Vanguard Russell 2000 ETF, has surged along with Financials. However, note how VTWO has pulled back after a series of small new highs all year long.
Chart 7: Small stocks represented by VTWO have underperformed VONE all year long, before rallying in September. This chart essentially captures the sideways move in Chart 4 -6 above, even as the Russell 1000 universe moved higher all year long. (A live version of the chart is here.)
Market Internals (Breadth) is Bullish Across Indexes and Key ETFs
A majority of stocks are trending higher across all time-frames in the S&P 500 universe and the Russell 1000 universe (See chart 8). More importantly, at the intermediate-term level, a majority of stocks are trending higher across key ETFs (see Chart 9). Thus, the current rally is broad-based, at least for now. In Chart 9, I cover the time from the Feb16 low to this month end. In Feb16, most of the key ETFs were in bearish territory. Now observer the weakness going into the US elections last Fall. The relative weakness in small and value stock sis also visible. However, at the right-hand edge, all the lines are safely in the green region, reinforcing the message that breadth is bullish.
Chart 8: The path of least resistance is finally higher across all time frames for a majority of stocks in the Russell 1000 universe. Thus, most stocks are heading higher over many different time intervals. The time frame doubles at each step from 25 to 200 days from left to right.
Chart 9: This schematic overview of key ETF internal bullish percentage from the Feb16 low to this month end shows that the trend is higher at the important intermediate-term (100-day) time frame. Observe that at the Feb16 low, breadth was strongly bearish. The breadth weakened going into the US election, then surged. Periodic weakness in value stocks is visible in 2017. This chart is a powerful measure of the health of the market.
Seasonality: The Fly in the Ointment
Seasonal patterns, with all of their variability, are pointing to down-side risk. For example, the $VIX remains low, as it should when the market is trending. I have arbitrarily plotted a blue line that is typical of some peak-to-peak cycles on the chart (see Chart 10). Since October has seen sell-offs before, the low VIX combined with headline risk creates room for seasonal risk going into the next month. Adding to this, the years-ending-in-7 patterns also suggest weakness going into the year end (see my take here; see Tom McClellan's charts here). Finally, Washington will run into various deadlines in December, and is always good for a headline or two.
Chart 10: The $VIX index is low again, and I have arbitrarily plotted a typical peak-to-peak cycle found on the chart to show that head-line risk could add a dash of seasonal risk in October. (A live version of this chart is here.)
As traders, we are always on the horns of a dilemma: Will the market do what we hope and expect, or not? My models are firmly bullish, and hence so am I.
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