Will Santa Claus Call to Broad & Wall?

Yale Hirsch of Stock Trader’s Almanac fame (and a perennial must own book now written by his son Jeff) coined the phrase, “If Santa Claus fails to call, bears may come to Broad & Wall”. Research showed that if the last five trading days of the year and first two trading days of the New Year (Santa Claus rally) did not show a positive return, a bear market or significant correction was likely during the coming year.

Bears love to point out that Santa did not call in 1999 nor 2007 when two devastating bear markets were about to unfold. However, Santa also did not call in 1990, 1992, 1993 and 2004, yet no bear market or major correction ensued the following year. Santa also did not come in 2014, but I am guessing that the 15% summer decline married that up. In 2015, Santa was a no show and stocks were in in the midst of a 15% correction which bottomed on January 20.

Conversely, Santa called in 2010, but stocks saw a 20% decline in 2011. Santa came in 2000 and 2001, however 2001 and 2002 were awful bear market years. 1997 saw a big Santa Claus rally, yet 1998 had a 20% correction. The same can be said about 1989 and 1986.

In the end, Santa Claus usually calls, which you would expect as down markets only occur roughly one third of the time. Over the past 46 years, the Santa Claus rally has been seen 74% of the time. Since 1990, it’s just under 70% and 75% since 2000. Detractors, however, will say that he has been absent two straight years. New trend beginning or will 2016 revert back to the tried and true?!?!

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Top Financial Tips to Year-End

This year-end is a very unusual one. Not only will the presidency be changing in early 2017,  but Congress will now join the party in power for the first time since the 2008 election and 111th Congress. That means for the most part, any legislation that passes Congress will likely be signed into law by the president. Before you dismiss this as a political post, read on.

Because Speaker of the House, Paul Ryan, has been in power for several years, we already know his economic plan, which just so happens to line up with Donald Trump’s plan. Besides the lifting of hundreds of regulations and repatriation of corporate cash overseas, the cutting of corporate and individual taxes will likely be number one for the 115th Congress.

It’s very rare for a party to sweep into power and have lower taxes as their top priority. With individual tax brackets likely to be reduced to three with the rates cut for most Americans, there are a number of unique year-end financial tips to be aware of as there is a strong likelihood that our tax bills will be lower for income earned in 2017 than 2016. It’s also possible that the IRS sees an unexpected decline in tax revenue for Q4 which could temporarily increase the budget deficit.

With all that in mind, it makes sense to:

  • Defer as much income as you legally can from 2016 into 2017. If tax rates are cut, you will owe less money. If they somehow are not, there shouldn’t be any harm.
  • Accelerate deductible expenses to year-end. Since taxes will likely be lower in 2017, you are better off taking your expenses in 2016 against the presumably higher tax rate. The deduction is worth more now.
  • Increase retirement plan contributions. This applies to company sponsored plans like a 401K or 403B since IRA contributions may be made right up until April 17, 2017 for the tax year 2016. If you haven’t maxed out your contribution for 2016 ($18,000), your company may allow you to do a one time or two time increase from your paycheck into your account to lower your reported income to the IRS for 2016. If you earn a year-end bonus, consider adding that into your retirement plan as long as you haven’t maxed out. And remember, for those age 50 an over, you can contribute an additional $6000 as a “catch up provision”.
  • Increase charitable contributions. Similar to the ones already mentioned, why not give more to charity in 2016 and deduct a larger amount against a presumably higher tax rate in 2016. Not only that, but on a humanistic level, it’s very worthwhile.
  • Realize net investment losses of $3000. The IRS allows each filer to deduct up to $3000 in net capital losses. That means if you have taken $10,000 in gains, you can take $13,000 in losses and write off the net of $3000 against your adjusted gross income. Any amount more than $3000 net in a given year is carried forward in future tax years.
  • Harvest tax losses. This is one of my favorite strategies year after year. If you have securities held at a loss, you are able to sell them and buy a similar but not essentially the same security to realize the tax loss. For example, if you owned American Airlines at a loss and you still believed the airlines were still a good investment, you could buy United, Delta, JetBlue or Southwest. You could also buy an exchange traded fund (ETF) which invests only in the airline space, like JETS. You couldn’t, however, sell the Vanguard 500 mutual fund and buy one of the ETFs which tracks the S&P 500, like SPY and IVV.
  • Required Minimum Distributions (RMDs). If you are 70 1/2 or own an inherited IRA, the government mandates that you take an annual distribution from your IRA, 401K, 403B, etc. This is not optional. Failure to do so results in penalties of 50% of the distributed amount.

I am sure there are other worthwhile tips, but these are a good start and ones I feel strongly about.

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Stocks Tired But No Reason to Sell Just Yet

Stocks are now in one of the most seasonally strong times of year within one of the most seasonally strong times of year. The big question is whether the market has used up most of the available fuel and needs a break first. Certainly, the last few days have seen a mild pullback. It looks like the bears have a tiny bit of work left to do on the downside. However, those looking for any significant price damage during the these final two weeks will probably be sorely wrong.

I say this every year, but there are few reasons to sell over the final few weeks. It doesn’t mean it can’t happen; it just means that it’s less likely to happen. The Fed is done. Earnings season is still a few weeks away. Washington will quiet down. Since 1990, only 2002, 2005 and 2012 saw any real selling and it wasn’t all that significant. We have some tired indices and some exhausted sectors, but I wouldn’t be holding my breath for a collapse.

Leadership remains strong. High yield bonds are hanging in nicely. Intermediate-term participation is solid.

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Fed to Hike Rates But All Not Well

Model for the Day

As with every Federal Open Market Committee (FOMC) statement day, there is a model for the stock market to follow pre and post announcement. Certain environments have very strong tendencies while others do not. Two meetings ago was one of the rare times where the models strongly called for a rally on statement which was correct as well as a decline a few days later which was also correct. Today, the upside edge is just outside a coin flip and certainly not worth playing based solely on this. While it’s also December option expiration week which has historically added a nice tailwind to stocks, that edge has also been a bit muted by the strength seen on Monday and Tuesday. On the bright side, there could be a strong and playable short-term trend to the downside starting by the end of the week, but we will have to see how the next few days play out.

1/4% Hike Against Mixed Economic Picture

Janey Yellen and her friends at the Fed have done an excellent job of preparing the markets for a rate hike today. I would say that it’s a 95% certainty. The Fed is going to raise the Federal Funds Rate today by .25%. Whether you want to attribute it to the Fed making an independent decision based on the economic data at hand or that Donald Trump’s agenda is assumed to be very pro-growth or that Paul Ryan will be running tax policy or even that stocks have become a bit frothy, short-term rates are going up today and next year.

Looking at what the Fed is supposed to be basing their decision, the economy, we see a mixed bag. Over the past three months, we have created 156,000, 161,000 and 178,000 jobs in the U.S which seems pretty good on the surface. However, that’s 200,000 less jobs than 12 months earlier. The manipulated unemployment rate is down to 4.6% with the real or U6 rate at 9.7%. And while the consumer price index (CPI) has finally started to uptick after percolating for years, it’s hardly hot and worrisome. Our economic output, GDP, is improving and now stands at just over 3% which is also finally good news. I fully expect that to click between 3% and 4% in 2017.

Velocity of Money Still Collapsing

Turning to an oldie but a goodie, below is very long-term chart of the velocity of money (M2V) produced by the St. Louis Fed. In the easiest terms, M2V measures how many times one unit of currency is turned over a period of time in the economy. As you can see, it’s been in a bear market since 1998 which just so happens to be the year where the Internet starting becoming a real force in the economy. Although it did uptick during the housing boom as rates went up, it turned out to be just a bounce before the collapse continued right to the present.

This single chart definitely speaks to some structural problems in the financial system. Money is not getting turned over and desperately needs to. It would be interesting to see the impact if the Fed stopped paying banks for keeping reserves with the Fed. That could presumably force money out from the Fed and into loans or other performing assets.

The Secret Behind Low Rates

Continuing to raise rates, as I have written about over and over, also makes our currency a lot more attractive to foreigners. Remember, money flows where it’s treated best. Since early 2008 here, in Street$marts and on the various financial channels, I have been a devout secular bull for the dollar, even when trillions were being manufactured by the Fed. For years, I sat alone in my bullish house before having company over the past few years. As I have written about, I truly believe that one of the main reasons Yellen and her inner circle don’t want to raise rates is because they are terrified of massive capital flows into the U.S. as the dollar index breaks out above par (100) which is already did and travels to 110, 120 and possibly higher, somewhat like tech stocks did during the Dotcom boom. Below is a chart I continue to show at each FOMC meeting. 120 is the next long-term target.

A soaring dollar would be great in the short-term for all except those who export goods. Our standard of living would go up. Companies with U.S. centric businesses would thrive. Foreigners would buy dollars in staggering amounts at a dizzying pace which I argue would make their way into large and mega cap U.S. stocks. Think Dow 23,000, 25,000 and possibly 30,000.

What’s so bad about that?

Eventually too much of a good thing becomes problematic. In this case, mass dislocations in the global markets would grow and that would almost certainly lead to a major global financial crisis later this decade. Think many elephants trying to squeeze out of a room at the same time. Think crash of 1987 on steroids. Yellen and the other smart people in the room must know this. You may not agree with their thinking and actions, but some of these people are scary smart.

I understand why the Fed is going to raise rates. I truly do. However, given our current mixed economic picture and the weakness, deflation and accommodative stances of central banks elsewhere, I believe that Yellen and her minions are barking up the wrong tree.

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Irrational Exuberance

This past weekend was the first official ski weekend for my youngest son and me. And boy was it cold in Vermont! But with mid-winter conditions, it was hard not to overdo it. I overdid it and now I am in a world of pain. Neck, back, quads, calves, fingers.

Anyway, as you can imagine, I am usually a chatty one on the lift. Since we typically ride the quad or 6 pack, we are usually with strangers. When people find out what I do for a living, they rarely ask questions except for the occasional “what’s the hottest stock right now”.

This weekend was very different.

Not only was I offered unsolicited advice on chairlift rides about investing, but I was also told that no one really needs a financial advisor. Everyone can do it themselves. I loved the guy who told me everyone should just use the robos to invest and call it a day. After all, they are super cheap and it’s all about cost. They didn’t like my analogy about driving a Yugo or finding the cheapest doctor or plumber.

If I could quantify the level of exuberance, I would say it was approaching irrational. Nothing like I experienced in late 1999 and early 2000, but that was once in a lifetime. The public is coming back to the stock market and higher highs await us. The problem is that the public tends to arrive late to the party and never leaves when they should. If someone told me 3, 4, 5, 6, 7 years ago that mom and pop wouldn’t start investing again on balance until Dow 19,000, I would have laughed in their face. But they are right.

This doesn’t mean much for the immediate future. The window I starting writing about for a decline exactly one month ago has essentially closed. Sure, we can and should see a 2-3% pullback. If everyone is looking for that, it won’t come right away. However, all of the warning signs I have written about for a larger decline have dissipated. Buying weakness is the strategy until proven otherwise.

Keep an eye on buying the most battered into the Fed meeting on Wednesday.

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Bulls Continue to Trample Ahead

On Wednesday, I gave a higher level overview of how the stock market is behaving along with the leadership and some key indicators. Nothing has really changed. Almost everything is severely overbought, but they can still become even more overbought. Pullbacks through year-end should be shallow and no more than 2-3%, lasting just a few days.

Another piece of good news for the longevity of the bull market came this week. The NYSE Advance/Decline Line scored an all-time high. That effectively insulates the bull market from ending for at least several months if not longer. Broad participation is there and weakness has to be bought until proven otherwise.

nyad

Additionally, high yield (junk) bonds are a whisker away from new highs as well. As you know, they are one of my favorite canaries in the coal mine. Bull markets typically don’t end with junk trading so well. That adds further insulation for the bull to live on well into 2017 if not longer.

jnk

Without any pullback, those looking for investment should find laggards, instruments that haven’t kept pace with the advance. Healthcare, biotech, staples, REITs, utilities and preferred stocks are a few to research.

Have a great weekend! My nose smells snow in Vermont and it’s time to makes some turns…

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Window for Decline Almost Closed

For the past three weeks, our models have been defensive regarding the stock market after the first week’s post-election surge. I often say that when certain conditions are present, a “window of opportunity” opens for a stock market decline. The longer time passes without a decline, the more likely the window will close. Today, the window is starting to close and I imagine that by two weeks from today, it will be fully closed, modest decline or not.

The  Dow, S&P 500, S&P 400 and Russell 2000 are all in gear to the upside and look strong, although definitely overbought. The NASDAQ 100, on the other hand, has given back all of its post-election hoopla and just doesn’t behave well. While that bellwether index is dominated by Apple, Amazon, Facebook, Microsoft and Google, which have been under strong downside pressure, it would be careless to dismiss this as just a few bad apples (no pun intended). It remains a red flag for now.

Looking at my four key sectors, banks, discretionary and transports are all acting very well and indicating good things for the bull market. Only semiconductors are questionable, however, they really haven’t done anything terribly wrong except see an outsized down day last Thursday. Further supporting excellent leadership is the performance of the materials, industrials and energy. With the defensive staples, utilities and REITs continuing to lag the rally, that adds further credence to the longevity of the bull market. I do think, however, that a short-term trading opportunity may exist as the Fed raises rates next  Wednesday and the most beaten down sectors begin to rally on that news.

High yield bonds are finally starting to kick it into high gear after breaking out to the upside on Tuesday. Even the NYSE Advance/Decline Line is ever so slowly inching back toward an all-time high. Unless something dramatically changes over the coming week, weakness is a must buy into January.

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Yahoo Finance Today & Quick Update

I am excited to join the good folks at Yahoo Finance for their live show today at noon. To watch, go to finance.yahoo.com and you should see the show streaming.

While so many people fretted over the election in Italy, the global financial markets don’t really seem to care this morning with the bulls in charge. Although December is a very positive time for U.S. stocks, it’s backloaded, meaning that the second half of the month is much more powerful historically than the first half of the month. In fact, the first two weeks of December tend to see lower prices.

With the Fed meeting next week and likely to raise interest rates for the first time in a year, I am keenly watching instruments which have been decimated in anticipation of that hike. Those securities, like many bond sectors, could reverse and rally on the announcement of higher rates, as counterintuitive as that sounds.

One area of increasing concern is the technology sector which has already given back all of its post-election celebration. In particular, the mega cap leadership of Facebook, Amazon, Apple, Netflix and Google is looking very tired and weak. While Netflix and Apple could still steady themselves and score fresh highs in Q1, the others look like they have further to go on the downside. Add in Thursday’s shellacking of the semiconductors and there is good reason to pay closer attention now.

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1991 & 1992 Offering Good Clues Too

Yesterday, I wrote about the analog with 1980. If I change my research parameters from presidential elections to similar price behavior during any year, I come up with a very different analog. The current market is first below and you can see the BREXIT bottom in the middle, followed by the big summer rally and period of digestion before the current rally began on the right side.

In 1991, we saw a massive rally after the U.S. and its allies expelled Iraq from Kuwait in Operation Desert Storm or the Gulf War. Stocks were range bound until December of that year before exploding higher like we have seen this month.

The other similar period just happens to be right after the scenario I discussed above. I shifted the BREXIT bottom to December 1991 with the current rally beginning in April 1992 as you can see below. This scenario more closely resembles today when you look at the number of stocks participating in the rally.

The good news is that in both cases stocks resolved themselves to the upside without any meaningful correction for some time.

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1980 a Good Analog for 2016

Since the election the financial media and pundits have been fascinated with labeling the stock market’s strong run as The Trump Rally. I get it. And it’s really only a silly name anyway. However, the market isn’t rallying just because Donald Trump was elected. If the Senate went blue, I would argue that we would seen a muted response. Equally, if not more important, is the fact that the GOP now controls Congress and similar to how the government looked in 2009 & 2010 when the democrats were in the same position, the republicans have at least the next two years to pass their highest priority legislation and jump start the economy.

I went back 100 years to try and find similar stock market behavior post-election as well as during the year and the only remotely close parallel was 1980 when Ronald Reagan defeated Jimmy Carter as you can see below. In 1980, the Senate went to the GOP for the time since the mid-1950s, however the House remained blue.

I added a chart of 2016 so you can see how they line up. Take away the BREXIT decline at the end of June and they look interesting.


The important takeaway is found on the far right of the charts. In both cases, stocks rallied to new highs after the election, however the current rally is stronger and longer than the one in 1980. Perhaps that is because Congress is all red now, but was split in 1980. If this analog is to continue, stocks should be peaking shortly as they typically do during this time of year and pullback for a few weeks. I would only expect a mild bout of weakness in the 2-3% range.

If you would like to discuss how these possible scenarios could impact your own portfolio, please reply to this email or call the office directly at 203.389.3553.

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