Could the White House Hand-Off Spoil the Santa Claus Rally?

The Dow broke out to all-time highs post-election, but history suggests stocks could struggle in the weeks ahead

Joe Bell, CMT
Nov 14, 2016 at 8:22 AM
facebook twitter linkedin


What a wild and historic week. After nine consecutive losing days for the S&P 500 Index (SPX - 2,164.45), we kicked off last week with a change in trend and a strong surge higher on Monday. The bounce came after FBI Director James Comey announced the reopened Hillary Clinton investigation had uncovered no evidence of criminal wrongdoing. For many, this cleared the last hurdle for what was expected to be an easy victory for Secretary Clinton on Tuesday night. Combined with the expectation that the Republican party would retain control of at least one house of Congress, the market felt at ease with the prospect of more of the same gridlock in Washington.

Well, that hurdle was a little higher than most imagined, and Donald Trump sent the world -- and U.S. equities -- into shock with his surprising victory. In addition, Republicans retained a majority in both the House and Senate. As the election results unfolded late Tuesday night and into the early Wednesday morning hours, Dow Jones Industrial Average (DJIA - 18,847.66) futures were down 800 points, and the SPX fell 5%. The SPX futures also hit their limit down trigger overnight, which means the contract could not trade at a lower price for the remainder of the overnight session.

Despite the overnight volatility, when the markets opened at 9:30 a.m. EST on Wednesday, all the losses were retraced, as the world calmed down and realized that the sun still came up and all was not lost. In an unexpected turn of events, U.S. equities surged dramatically higher through the end of the week, and the SPX posted gains of 3.8% for the week. In fact, the Dow is now trading at an all-time high.

djia weekly since jan 2014
Chart courtesy of StockCharts.com

Despite the broad-market rally, there were some definite winners and losers underneath the surface. We saw incredible divergences between sectors post-election, with participants rewarding industries they feel will benefit under President-elect Trump and punishing others. Given Trump's promise to invest in the country's infrastructure, basic materials and industrials surged higher. Biotechnology and pharmaceutical companies also led the way, as most expect Trump and a Republican-dominated Congress to quickly repeal President Obama's Affordable Care Act. Last, but not least, banks and other financial stocks had an incredible week, as Trump will be pushing to lessen financial regulation and perhaps eliminate Dodd-Frank.

But it wasn't exactly roses and sunshine for investors in consumer staples, technology, and utilities. Longer-dated Treasuries also took a massive hit last week, as the iShares 20+ Year Treasury Bond ETF (TLT) lost 7.4%.  

Although a rally of this magnitude in one week is tough to predict, our Senior V.P. of Research Todd Salamone outlined in last week's column several reasons why any post-election decline would likely bottom out in very short order. Unlike the action ahead of the Brexit vote, investors were buying SPDR S&P 500 ETF Trust (SPY - 216.42) puts to hedge at their highest rate in 15 months. In addition, we saw heavy CBOE Volatility Index (VIX - 15.39) call activity ahead of the election, which is also a popular hedge against market panic. In the end, it played out exactly as Todd suggested, with the overnight sell-off reversing before the market opened, and the panic ultimately proving to be short-lived.

spy 10 day bto options put call ratio

Nobody is talking about it, but we are quietly nearing the end of the first positive earnings season since the first quarter of 2015. It has been a strong quarter, as all 11 sectors have higher growth rates than analysts expected coming into the quarter. Earnings were expected to decline 2.2% for the quarter, but right now, results have improved by north of 2%, with less than 10% of companies left to announce. Real estate, utilities, and financial companies are reporting the largest upside surprises. Only three of the 11 sectors are reporting negative year-over-year results, with energy leading to the downside.  Looking ahead, analysts expect earnings and revenue growth to continue in the fourth quarter, and most expect them to be even greater than the third-quarter results.  

Speaking of the fourth quarter, we are entering a historically bullish time of year. Schaeffer's Senior Quantitative Analyst Rocky White studied the historical Dow returns from Election Day through the end of the year, and the average return for the DJIA is a gain of 1.43%, with returns positive almost 60% of the time. One thing to note is that election years tend to be a little more volatile toward the end of the year than years without an election, as reflected by the standard deviation.

dow rest of year returns since 1900

Taking it a step further, I wanted to see what happened when the newly elected president is from a different political party than the current president. Since 1900, this has happened 11 times -- and the results are much worse than when the same party stays in power. As you can see, the average return through the end of the year is a loss of 1.49% in these instances, compared to a gain of 3.22% when the same party remains in the White House. Given the relatively low volatility we have experienced ahead of the election, an increase in volatility by year-end would not be a surprise.

dow rest of year returns election party change

If the theme of 2016 indicates anything about the upcoming week's price action, this big, fast rally we've just experienced will be followed by a pause in action in the short term.  Even though the Dow is at an all-time high, the SPX, Russell 2000 Index (RUT - 1,282.39), and Nasdaq Composite (COMP - 5,237.11) all must contend with potential resistance from their previous highs. After the fast move last week, one would expect these areas to act as resistance or create some sort of speed bump going forward.  

spx daily since may 2016
Chart courtesy of StockCharts.com

This week, we have a lot of important economic data that will be released.  On Tuesday, October retail sales will be released, while Wednesday brings the producer price index (PPI) and Thursday the consumer price index (CPI). Retail sales will be a key indicator for economists to see if consumer spending continues at the modest pace it has been. In addition, earnings this week are led by many retail names, including Dick's Sporting Goods (DKS), Lowe's (LOW), Target (TGT), Best Buy (BBY), and Wal-Mart Stores (WMT). 

The inflation data is yet one more point for the Federal Open Market Committee (FOMC) to consider when they make their interest rate decision at the December meeting. As of this writing, the CME Group 30-day Fed funds futures price currently indicates a 76.3% probability of the Fed increasing the interest rate by 50-75 basis points at this upcoming meeting. 


Continue reading:


Sign up now for a trial subscription to Schaeffer's Expiration Week Countdown! We'll send you 5 trades for expiration week, each targeting double- or triple-your-money gains in less than 5 days.

 


A Schaeffer's exclusive!

The Expert's Guide

Access your FREE trading earnings guide for Q3 before it's too late!


  
 

Partnercenter