2016 Stock Market Forecast & 2015 Market Review

By Lawrence G. McMillan

Usually we make this the topic of a longer article at year-end, but frankly we are not holding positions for anywhere near a year, so this is just a mental exercise – not having a lot to do with our style of trading.

Besides, last year the big thing was that years ending in “5" are extremely bullish.  Well, this one wasn’t, which just shows that seasonals don’t always work.  Of course, with this one you have to wait another ten years to see how the next signal does.  That’s ridiculous, of course, but it gives CNBC something to talk about.

Recap

The year was basically flat, after a rocky, negative January.  The one severe excursion to the downside was in August, with a retest in September.  Otherwise, the market was volatile within a fairly narrow trading range of 2040-2135.  It is just now beginning to probe out of the downside of that range, and simultaneously establishing a downtrend (lower highs and lower lows) in $VIX.

Presidential Cycle

For the record, we are the entering the fourth year of the Presidential Cycle.  The theory is that the market moves somewhat in relationship with the Presidential election cycle.  In year one, the market might decline, as the new President enacts tougher legislation, figuring that the public will forget about it by the time the next election comes around – three years hence.  The second year can also be a difficult time for stocks, but there is usually a bottom late in the year that carries the market higher into and throughout the third year.  Then, in the fourth (election) year, the financial spigots are opened as the President tries to get re-elected or to keep his political party in power.  That causes the market to rise sharply.  

Having said all of that, the Presidential Election cycle has been off in some cases.  For example, 2008 was a very bearish year, when it was supposed to be a bullish one.  2012 was bullish, however.  

There is plenty more data of this type in the Stock Trader’s Almanac, by Yale and Jeff Hirsch, if this sort of thing interests you.

Calendar Cycle

Years ending in “6" have generally shown modest gains of less than 10% on average, with most of those gains coming in the last quarter.  That is especially true in election years, with the market bolting upward just before and after the Presidential election.

Cumulative Breadth

Now, moving away from longer-term seasonals, let’s look at some broad technical data.  The first is cumulative breadth, which we have written about often before (including the feature article in the last issue).

Simply stated, cumulative breadth has been a negative problem for stocks for some time now – since July of 2014.  Whether one looks at cumulative issues (the running total of daily advances minus declines) or looks at cumulative volume (the running total of daily advancing volume minus declining volume), the issue is the same:  cumulative breadth lines have been deteriorating while the stock market has remained the same.  That is negative, and usually it takes a major market correction to “reset” things.

Obviously this is not a timing indicator, for the condition has persisted for a year and a half.  So what we have said is that one should not ignore sell signals when they arise.  At the current time, of our major indicators, the weighted equity-only put-call ratio is still on a sell signal, and the $SPX chart is in a downtrend.  Therefore, we are carrying a long SPY put position (Position S843) because of the negative breadth divergence. If both of those sell signals reverse, we would exit the puts until sell signals arose at a later time.

Volatility

The period of extremely low volatility was broken this past year, when prices plunged (briefly) in August.  Not only that, but volatility has generally been increasing all year.  The 100-day historical moving average of $SPX has increased from 11% to nearly 20% in the past year.  

One can’t blame the long-awaited, late-year rise in interest rates for that, but a continuing increase in interest rates will certainly be a factor in potentially increasing volatility.  Will we ever return to the state of being able to earn interest in our savings accounts and brokerage accounts that have credit balances?  Probably not anytime soon, but that would certainly be a boon to option writers if it were to occur.  It will, eventually.

Summary

The next few weeks could be very interesting in determining how the market will move this year.  The last time that $SPX stumbled this badly coming into the Santa Claus rally season was 2007, and there was no Santa Claus rally that year.  Moreover, January 2008 was a disaster (as was the latter part of the year as well), with $SPX losing 250 points from its December highs to its mid-January lows. That year, $SPX was also in a downtrend as well,m approaching the end of the year. So we are remaining cautious unless $SPX can trade to new highs and maintain them.■

This article was originally published on 12/28/15 in The Option Strategist Newsleter.