The Highest Probability Scenario For The Rest Of The Year

Trying to game plan for the rest of the year, given what we currently know, means examining a series of different scenarios and assigning a certain probability to each.  Today we'll take a look at the scenario that we believe has the highest probability of occurring this year.  We talked on Wednesday {the post immediately below this one} about a environment similar to 2015 through early 2016.  If that scenario should pan out then we think it would look something like what we're  showing in the chart above.  The chart is again from Tradingview.com although the annotations are mine.  You can double-click on the chart to make it larger if you would like.  What I want you to focus on under this scenario is the blue lines we've attached to the actual chart of the S&P 500 in the upper left hand corner.

Under this scenario we think you could see something like this.  Stocks spend much of the year consolidating their gains from the past two years.  The positives of underlying economic growth we are seeing and gains from the tax cuts runs into the worries of higher stock valuations, higher interest rates and higher inflation.  Also as the year ages we start adding political risk into the equation from the upcoming mid-term congressional elections.  In this scenario, stocks spend a better part of the spring finding a level of equilibrium from which they can again start to advance.  Markets then manage a stair step rally into early summer that potentially takes us back to the old highs set in January.  From there markets proceed to give most or all of that rally back, potentially retesting the spring lows.  Once we get into the fall and once the outcome of the elections are priced into stocks there is a possibility we again attack the old highs from January.  Under this scenario we see stocks showing price appreciation of 7-10% this year.  Now obviously it is unlikely the year will pan out exactly as I've drawn the lines.  They are a hypothetical general illustration.  Still it seems there is a very high probability that a scenario similar to what we've shown above is what we'll have seen once 2018 winds down.

Some of you might find this analysis a bit of a come down and such an environment would look poor compared to 2017.  However, keep in mind we had an explosive move at the beginning of the year.  We were up about 6% in most markets in January.  That sort of parabolic rise is simply unsustainable longer term.  Also individuals in modern times divide time periods mostly into years.  A better way to measure stock markets is in cycles.  If you look a bit further out and start with the last downdraft we had in stocks in early 2016 then you'll see we've been up more than 50% since then.  Markets viewed this way show a much more positive light.

Estimated probability of this scenario occurring 45-70% by our analysis.

Long ETFs related to the S&P 500 in client and personal accounts.  Short S&P 500 in a personal account as part of a separate individual strategy.