In my Oct. 26 MarketWatch column, I argued that a drop in the S&P 500 Index to 2,675-2,587 points would be followed by a rally toward 2,900.
The chart below, published in the Oct. 28 Profit Radar Report, provides a visual projection of the S&P 500 SPX, -0.83% path described above. (Here’s the Oct. 26 MarketWatch column.)
On Oct. 29, the S&P 500 fell to 2,604 and has since rallied to well above 2,800. Will this “pop” be followed by the projected “drop”? Based on Elliott Wave theory (EWT), the answer is: Yes, sooner or later. While EWT is part of my toolbox, I never rely on any one single indicator. Unfortunately, at this time, other indicators do not agree with EWT.
EWT vs. seasonality
As everyone knows after this week, 2018 is a midterm election year (based on the four-year presidential-election cycle). Two patterns unwind fairly consistently in midterm years:
1. Historically, stocks fall about 18% (S&P 500 average of past five cycles) into the midterm low. However, the 2002 loss was unusually large (34.5%). Excluding 2002, the average loss over the past four cycles was 14.38%. In 2018, the S&P 500 lost more than 11% of its value, twice.
The Russell 2000 Index RUT, -0.89% lost as much as 16.3%, and the Nasdaq as much as 14.6% in 2018. This is closer to the 14.4% average than the S&P 500. The Dow Jones Industrial Average DJIA, -0.65% was stronger, and lost no more than 10.5% this year.
2. Historically, stocks rally from the mid-year (2018) low to the pre-election year (2019) high. The average S&P 500 gain over the past five cycles was 36.8%. (The chart below, published in January 2018, shows individual cycle gains.)
It’s rare for the S&P 500 to pop more than 2% following the day after an election (midterm or presidential), but it rose 2.1% this time. Since 1950, the S&P 500 jumped more than 2% the day after only twice, and more than 1% six times.
This is what happened the other eight times when the S&P 500 gained more than 1% on the day after an election:
• One month later: The S&P 500 was up 62.5% of the time, with an average gain of 1.4%.
• Three months later: The S&P 500 was up 87.5% of the time, with an average gain of 6.2%.
• Six months later: The S&P 500 was up every time, with an average gain of 9.6%.
Although the S&P 500 has been following my projection, seasonality tells me not to be dogmatic about the next move.
It’s best to keep an unbiased mind, and monitor short-term breadth, momentum and sentiment gauges to assess if this rally is running out of steam, or not.
A more detailed S&P 500 forecast and other important factors worth considering right now are listed here.
Simon Maierhofer is the founder of iSPYETF and publisher of the Profit Radar Report. He has appeared on CNBC and Fox News, and has been published in The Wall Street Journal, Barron’s, Forbes, Investors Business Daily and USA Today.