Orlando's Outlook: What a difference a year makes

01-13-2017

Bottom line At this time last year, we were slitting our collective wrists. The S&P 500 had plunged 6% in the first five trading days of calendar 2016, marking the worst-ever start to a new year by a wide margin. Investors were panicked over a potential Chinese hard landing, the prospect of four quarter-point rate hikes by the Federal Reserve, plummeting oil prices and continuing U.S. dollar strength. What would have ordinarily resulted in a disappointing full-year equity market, however, was salvaged in November and December by Donald Trump’s surprising presidential victory and the stock market’s strongest post-election rally in history.

Fast forward to today. The equity market’s powerful year-end rally bled into the first week of calendar 2017, with the S&P rising a solid 1.34% over the first five trading days. With the prospect of a more market-friendly set of fiscal policies under President-elect Trump, this early stock-market strength bodes well according to the forecasting of the time-tested January Barometer.

Early January Barometer suggests 2017 will be a positive As a favorite beginning-of-the-year forecasting exercise, we routinely visit one of the stock market’s most popular rules of thumb, the January Barometer: as the first five trading days of January go, so goes the entire month; and as the month of January goes, so goes the full year.

Since 1950, Jeffrey and Yale Hirsch of the Stock Trader’s Almanac report that 69% of the time (46 out of 67 observations), the direction of the year—up or down—was the same as that of its first five trading days. It’s even more accurate when the first five trading days of the year are positive, as they are this month. When that happens, the stock market has finished the year in positive territory 83% of the time (35 out of 42 instances). Investors tend to tip their hand early with beginning-of-the-year retirement and college-savings contributions and changes in portfolio allocation.

Solid start Over the first five trading days of calendar 2017, the S&P enjoyed a price-only gain of 1.34%, from 2,238.83 on Dec. 30, 2016, to 2,268.90 on Jan. 9, 2017. When including dividends, the total return over this period improves to a gain of 1.40%. By historical comparison, the Almanac says that over the past 67 years the first week has posted a median gain of 0.50% and an average gain of 0.29%. So, this year’s powerful first-week returns are well above average.

In fact, looking at the history of the January Barometer, this year’s 1.34% return would rank as the 21st best for the S&P’s first five days. Full-year stock-market performance was negative in only one of the other 20 (down 17.4% in 1973), with average full-year performance up 16.1% and median performance up 16.5%.

Starting to price in the Trump rally For the record, we are not expecting the S&P will approximate 2,600 by year-end 2017, which is what historical performance standards would imply. But if we revisit the 5% intraday spike for S&P futures on Nov. 9 to 2,028.50—when investors were shocked to realize Trump might actually win the presidency—then that subsequent rally would measure up to roughly our current full-year target price of 2,350. So it appears the powerful 10% post-election rally actually started to discount some of this year’s expected gains.

Three times a charm? We’ve suffered through three consecutive down Januaries in 2014, 2015 and 2016, something we’ve experienced only twice since 1950 (that streak has never extended to four consecutive years). While it’s clearly not statistically significant, in breaking the two previous down cycles, January 1971 was up 4%, while January 2011 rallied 2.3%.

Look across the valley Are there any fundamental developments we might encounter over the balance of this month that might upset the applecart on its way to a positive full month of January and full year in 2017? We think so, and are closely watching three events occurring before the end of the month:

  • Inauguration Day President-elect Donald Trump will be sworn in as our 45th president on Friday, Jan. 20. In his inaugural address to the nation, we expect he will outline a much more pro-growth, pro-business and market-friendly agenda than President Obama brought to the White House eight years ago. “Trumponomics” include the prospects of corporate and personal tax cuts, deregulation, repatriation, infrastructure and defense spending, as well as fixing health care, immigration and trade. All of these collectively could unleash moribund corporate and consumer animal spirits and boost GDP growth from an anemic 2% run rate over the past seven years back to a trendline of 3% or better by 2018.
  • Fourth-quarter GDP The flash reading of fourth-quarter GDP will be released on Friday, Jan. 27. Bloomberg and Blue Chip consensus both estimate growth of 2.1%, versus the third quarter’s 3.5%. We’re at 2.5% here at Federated, and the Atlanta Fed’s widely followed GDP Now model is at 2.9%.
  • Next FOMC statement comes Feb. 1 The Fed hiked interest rates a quarter point at its December policy-setting meeting, its only rate hike in 2016 and just its second in nearly a decade. To be sure, we don’t expect any policy changes before its mid-March meeting. But the Fed surprised markets last month by suggesting it may be on pace for three rate hikes in 2017, compared with the two we and many others anticipated. Recall that last year at this time, the Fed spooked the markets by predicting it would execute four quarter-point rate hikes over the course of calendar 2016, but pulled the trigger only once. That didn’t prevent its misguided December 2015 sentiment from helping to tank the equity markets 13% into mid-February 2016. So, with the prospect of stronger economic growth from Trumponomics comes the potential for higher levels of inflation, which could introduce a more aggressive pace of Fed tightening that could unsettle markets.

Stay tuned We plan to follow up with January Barometer, Part II in early February, after we have investment returns for the entire month, to see what potential full-year market implications we can draw and to discuss what the top-performing industry sectors may be for the full year. 

To see Phil Orlando’s thinking in action, click here.