Topic: Historical model forecast suggests a flat 2018, with the potential for a volatile year. The impact of tax law changes and mid-cycle elections could be the wild cards posing the biggest risks to my forecast. A flat market forecast implies technical analysis will be more relevant than ever: so I show a new tool using SCTR and the Chande Trend Meter to make a joint measurement of relative and absolute trend strength.
Chart 1: The 2018 forecast assuming a starting value of $SPX 2682. The model is essentially flat, i.e., it is not expecting strong trends, but historical data cannot fully account for the just passed changes to the tax laws, so please note the wide forecast error bands.
I chose the recent historical presidential terms with the highest correlation to the first year returns for the Trump term. The average scaled return was essentially flat in the second year of each of those presidential terms, with plenty of volatility in the returns, as expressed by the wide 1-standard deviation bands in Chart 1. The same model worked well in 2017 (see Chart 2).
Chart 2: The Second-Year expected scaled return from recent history is essentially flat, with wide bands, so I expect a volatile year, with the potential effects of tax law changes and the mid-cycle elections as wild cards. Any return within the wide bands would be a successful prediction, which isn't saying very much.
Chart 2: The Post-Election Year Model I developed in April worked very well this year, with the closing value on 12/27 being quite close to the year-end model forecast as denoted by the average return of the market during selected presidential terms.
Risks to the 2018 Forecast
The historical data suggest 2018 could be a volatile year. The biggest risk is that the historical data cannot account for the impact of tax changes enacted at the end of 2017, which could be a wild-card on a stock-by-stock or sector-by-sector basis. 2018 is also a mid-cycle election year, so the three months going into the election and the two months coming out of it are likely to be affected by head-line risk and election results.
Year-End Market Trends are Strong
As we should expect from the year-long rally, market internals are strong going into the year end. First, the trend-check carpet is all green, and second, the path of least resistance for the Russell 1000 universe is also higher.
Chart 4: The market is trending higher across all four time periods and across key market indexes. Market breadth increases from left to right, from 30 to over 2000 stocks. The time interval doubles at each step from top to bottom, starting at 25 days. (The details of the trend-following models are here.)
Chart 5: The path of least resistance is pointing higher for the Russell 1000 universe. This means more stocks are trending higher (than being flat or trending down) across all four time periods from 25 to 200 days. Thus, the market is trending higher across multiple time periods across a broad swath of stocks.
A New Tool: Joint Comparison of Relative and Absolute Trend Strength
Technical analysis will be even more useful next year, and here is a new group/sector comparisons tool. The daily SCTR and CTM value for the reference index or ETF are subtracted from the respective values for the other sector or index ETFs. A scatter plot shows relative changes in performance (via SCTR) on the horizontal axis, and absolute changes in trend strength (via CTM) on the vertical axis. The reference ETF is at (0,0) or the center of the plot, and other objects being compared will "rotate" around the reference as they strengthen or weaken, on either a relative or absolute basis.
For example, a plot such as Chart 6 using the SPY ETF compares the relative performance of key sector ETFs and index ETFs along the x-axis using the SCTR values, and their absolute trend strength along the y-axis via the Chande Trend Meter (CTM). Thus, the upper right quadrant has objects that are stronger than the market on both an absolute and relative basis. All objects to the right of the y-axis have higher relative strength than the market. All objects above the horizontal axis have stronger absolute trend strength than the market. Counter-trend traders should study the lower left quadrant; trend-followers will find the upper-right quadrant the place to find opportunities.
Chart 6: A new tool: I compare absolute trend strength and relative trend strength using the SPY ETF as the market benchmark. The SPY ETF is at (0,0) at the center of the plot. The strongest groups are in the upper right hand quadrant, and the weakest groups are in the lower left hand quadrant. Another variant is to use the weekly CTM.
Thank You All, and A Happy New Year!
I hope the new tool will be a good holiday gift to my many loyal readers, and will encourage new readers to subscribe to the blog using the easy link below.
I want to thank all of you, dear readers, and Chip Anderson and Company for all their help and encouragement.
I wish you all a Very Happy 2018!