What a start to the 2018 stock market!

Every now and then, a horse will break from the gate and then lead the field to the end of the race. Similarly, but not as rarely, a football or basketball team will score first and stay ahead, with no lead changes, until the game ends.

How often does the stock market’s opening week foretell the rest of the year?

This is an especially interesting question this year. Last week, the market opened higher—not just for the week, but for every day of the first week.

And it did not trade higher by just a tiny amount. By week’s end, it had gained 2.60% for the S&P 500 and 4.02% for the NASDAQ 100.

How many times since its 1928 inception has the S&P 500 climbed more than 2% in its first four days? This year’s 2.60% marks the 20th time. When that has happened the previous 19 times, the S&P has gone on to gain on average 11.4% during the rest of the year. It lost money only three times, although one was a pretty big stumble—49.53%. Of course, that occurred in 1938 in the middle of the Great Depression.

Looking at the last 67 years (since 1950), the average return was 14.32% when the market started the year up 2% in the first four days, with only two losses among the 15 occurrences. The greatest loss of the two was just 3.23%. The average gain of the 13 winners was 16.86%.

But as they say in the TV promotions, “Wait there’s more!” Remember I mentioned that this year started with all four days gaining ground. It turns out that occurrence is even rarer. Since 1961, it’s only occurred eight times before this year. By comparison, the “greater than 2%” start previously discussed occurred 14 times during the same time period.

In the eight times that the S&P was up all of the first four days of the year, stocks have gained every time over the next 250 trading days (roughly a year). Gains have ranged from 0.24% to 16.04%. They have averaged a 9.46% return (median 10.47%).

It does appear that the leader as the race begins has been a good indicator of how the race ends … at least when it comes to the stock market.

Market update

Yes, the first few days of the new year have been terrific for domestic stock market indexes. Although I note that international stocks did at least as well this week, led by a 4.27% gain by emerging-market stocks.

Tune into our webinar on January 18 for reasons why we believe that the addition of global strategies to your portfolio this year is important.

Unfortunately, this week’s gains for stocks of all flavors have not been matched by the price behavior in the bond markets. Across the board, losses were registered for the bond indexes last week.

Although we did not see many signs of overheated price increases in the ISM service and manufacturing reports last week, most price reports internal to the studies were up. Commodities followed suit and posted gains during the week. Gold continued its strong year-end rally.

We’ll get more inflation data this week. Make sure you watch our daily All-Terrain regime reports (available on our Hotline and home pages) for any evidence of a change they may cause in our market environment.

As I have been reporting, I have been concerned that the early January peak that we tend to get in the market was scheduled, according to our Political Seasonality Index (available post-login in our Solution Selector under the Domestic Tactical Equity category), to occur at the close Friday. This is earlier in the new year than usual.

I have also been worried that the market was in overbought terrain. Now with last week’s New Year’s rally, it is firmly entrenched in overly bullish territory.

Even the four-day study previously mentioned makes me anxious. It seems that although the full-year prognosis is very positive, the rest of January’s performance, from the rare occurrences I detailed, is not nearly as good. Since the S&P began, when that Index has gained more than 2% in the first four days of the year, the S&P 500 has only been up just over 50% of the time during the remainder of January, with a below-average “rest of January” gain. Combine that with what I discussed last week—that stocks for the last 20 years have tended to be lower for the month of January—and you may understand my concern.

Since late last year, I have been forecasting a better-than-average year for stocks in 2018. At the same time, I have expressed concern over the likely course of stocks in January. As I have said, though, it’s not likely that any weakness or sideways motion for the rest of the month will be all that damaging—more in the 5% to 10% maximum-drawdown area.

Certainly, the sentiment indicators are not helping the bullish short-term argument. After three years and better than 200% gains in the S&P 500, individual investors have just recently become more than 50% bullish as they approach levels not seen since 2010. Similarly, earnings analysts have spent that same time frame downgrading more company earnings with their quarterly revisions than they raised. But this week they hit a level of positive revisions not seen since 2010.

AAII Bullish Sentiment

These are both contrarian indicators. In other words, historically, the higher these numbers go, the more likely a stock downturn becomes. For example, you can see from the earnings revision chart and accompanying S&P 500 chart, that the last time positive revisions were as high as they are today, stocks were in the midst of a decline of over 15%.

S&P 1500 Earnings Estimate Revisions

S&P 500

Some would put the current high price-earnings (P/E) ratio into the bearish camp of indicators, as well. It too has just recently moved into the rarefied air last seen in 2010. But as I have been saying for more than a year, high P/E ratios can indicate a lower probability for the continuation of a bull market, but their timing is lousy as the chart shows that they can remain elevated for a long time while the stock market just keeps going higher.

S&P 50 Trailing 12 Month P/E Ratio

In any event, we’ll see whether the earnings reporting season commencing this week will continue to surprise and justify these positive revisions and more. This has been the case since 2016’s second quarter and seems likely to continue this quarter, thanks to the tax cuts and reduction in regulations brought to us by 2016’s voters and the new administration in 2017.

Certainly, economic reports of late have been buoying the stock market ever higher. Last week was no exception as 10 of the 17 reports outperformed economists’ projections (four underperformed and three remained the same).

Similarly, our intermediate-term strategy indicators remain fully invested and even leveraged in some cases. Short-term measures also are positive. The sole exception is our S&P Tactical Patterns strategy, which became increasingly more bearish on a contrarian basis last week as the week’s gains continued to mount.

So if I had to bet on whether the S&P 500 would come out ahead in 2018, I’d take that bet. But there’s likely to be a slowdown from last week before the race is over.

All the best,

Jerry

Jerry C. Wagner is Founder and President of Flexible Plan Investments, Ltd. Formerly a tax and securities attorney, Mr. Wagner recognized early on that technology and hedge fund techniques could be applied to help individuals successfully invest, while managing their downside risk. After spending time pioneering new techniques in market analysis, designing quantitative methodologies, and managing investment portfolios, Mr. Wagner founded Flexible Plan Investments in February 1981.

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