Chart Talk {07.17.18}

One of the reasons I've always wanted to write on this blog is that I thought it would be helpful and fair to clients for there to be some record of what I'd been saying.  Whether close to being correct or wrong, I think it helps that people can go back and see what I've been saying in both good and bad times about topics I think interest my clients.  Besides investing is a humbling game and the best lessons are the ones where your analysis was not correct or not as correct as perhaps you would have liked.  Being able to go back and revisit an incorrect call hopefully helps one become better at investing in the future.

Today I want to return to an article I wrote a few months ago.   Back in February I published a post that I called "The Highest Probability Scenario For the Rest of the Year".  The chart featured above was in that post.  Back then we were taking a look at different possibilities for stocks given the nearly 10% correction we'd seen at that time.  As the article states the above illustrated scenario was the one that I thought carried the highest probability of occurring the rest of 2018.  I estimated the probability of us seeing something close to this pattern back then was between 45-70%.  This is part of what I said back in February on how I thought 2018 might potentially unfold.  

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. 

That second chart directly above is an updated version of the S&P 500 from February. Both are on a weekly time frame for longer term comparison.  I've also redrawn the lines as closely approximating what I'd originally noted last winter.  While not exactly perfect you can see we've followed pretty closely the pattern I laid out back then.  Now of course all of us are more interested in what might come next rather than what's already occurred.  If we knew for sure what the future holds than investing would be easy.  Instead on any given day we are looking into a crystal ball that is at best opaque.  What I would note is that many of the factors we sited back last winter are still with us today.  Valuation is less of a concern because corporate earnings continue to be stellar.  However,  interest rates are higher and inflation may be picking up if certain indicators are factored in.  Also we are now in the thick of the summer season for the Wall Street crowd and you know what I think about that.  Finally, the clock keeps ticking on the countdown to this fall's elections. President Trump continues to brawl with the Washington political establishment, progressives and most of the news media.  That fight will be carried over in the fight for control of the House and the Senate in November.  I don't believe political risk is much of a factor yet in stocks but it has the potential to become more of a possibility as we close in on the upcoming elections.  Finally I'd note that traditionally we are entering the weakest period of the year for stocks.

Now I have no idea where stocks are headed in the short run.  If I'm going to point out some potential headwinds I also need to note that the US economy is hitting on all cylinders right now and ultimately positive economics, fundamentals and earnings are what will drive stocks in the long run.  For all I know stock prices could quietly trend higher in the months ahead as positive economic news trumps all other concerns.  If I had to bet on what is the higher probability scenario over the next 12-18 months it would still be for higher stock prices.  However, I think if we only talk about the positives then we are not giving you an accurate or fair look into what could possibly occur in the next few months.  The scenario I'm discussing here may not happen or it might not look like I've laid it out above but you know it is a possibility and so far this year it's been pretty spot on target.

Finally back in February we ended that article with this below:

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.

Markets move in fits and starts.  Like a river they ebb and flow not only with the seasons but also with all the millions of data inputs that find their way into them each day.  We have seen a substantial move in stocks over the past 17 months.  An investor who had bought the S&P 500 ETF, SPY on the close of February 11, 2016  would have paid $182.86 per share and would have hit almost the cyclical bottom for this current move up.  As of yesterday's close he or she could have cashed in that trade for a price of $279.34, a gain of nearly 53% with dividends not factored in.  We may or may not hit a rough patch over the next few months but if we do, and based on what we currently can see on the economic horizon, it should be viewed within the normal patterns of a secular bull market.  Nothing on the horizon so far is changing my view on that.

Both charts are from TradingView.com although the annotations are mine.  Also this will be the only post this week as I'm out and about and also taking a few days of R&R on the back end  We'll be back with regular summer posting next week.

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.