Bulls win battle between donkeys and elephants

It’s amazing how little press and media attention the midterm elections have garnered this year until just recently. With the control of congress hanging in the balance we were expecting more hype from party central, but it has been rather subdued this time around. It’s not as if Obama is the most popular president, au contraire, and everything is hunky dory here in the States and around the world.

Midterm elections are usually quieter with lower voter turnout than the presidential election – but not this quiet. In fact, it is this low turnout out that usually fuels the inherent House seat loss by the president’s party. The fervor that brought the sitting president in has cooled and the opposition is usually more zealous on the local level, generating congressional gains. But this year there are several hot button issues in play right now and perhaps that is dragging attention away from the midterms.

ISSUE #1: Geopolitics. Eastern Europe and the Middle East are the hotspots of the day – activity on the other volatile geopolitical fronts from Asia to Africa have been on the back burner recently. Even the situation in the Israel/Gaza theater has subsided somewhat. It’s pretty much all ISIS (Islamic State in Iraq & Syria or ISIL or just IS) all the time these days.

Granted the Islamic State is a nasty bunch of violent extremists and arguably the most formidable terrorist group at present, but we are not convinced the IS threat is so great. If it were, the US military would not be tiptoeing around with airstrikes and a long haul plan. If IS was such a clear and present danger, we would not be keeping US ground troops off the table – that is infantry and marine divisions not combat advisers.

While IS has quickly swept through the Levant and is controlling some prime oil real estate, they have no air force (and killed anyone who could maintain and operate the air materiel they captured) and no navy and somewhere where between 20,000 and 31,500 fighters of dubious capabilities. Most findings indicate that they have little heavy armor and firepower and instead sweep in like a Viking raid in the Dark Ages to pillage and plunder and have little capacity to hold territory.

Yes, they have been cruel and lethal and successful until now. But it seems over the top to commit so much attention to such a small rag tag force, just because they may strike the West. Perhaps this is the Obama administration’s military distraction. Or perhaps it’s pride messing with us because this is happening in the bed we made in Iraq.

The more pressing geopolitical issue would seem to be what Putin is trying to do in Ukraine and Eastern Europe and potentially on all his borders. Left unchecked Putin will run roughshod over his neighbors and international diplomacy. But if more containment and sanctions are levied on Russia and begin to squeeze the economy it may be able to change the high regard in which the Russian people hold Putin so that he will change course or be removed.

ISSUE #2: Immigration. Nobody wants to touch this right now with a ten foot pole, not to mention an opinion poll and it is not likely to be addressed until 2015 and its doubtful anything will get through unless the Republicans take control of the Senate. Then we may actually have the potential for reconciliation between the House and Senate on this and some old-fashioned compromise between a Republican Congress and Democratic White House. But we are not sure we’d take that action.

ISSUE #3: Obamacare. Well, after a lot of skepticism and wrangling (including from us internally), the Affordable Care has not hurt people as much as its fiercest opponents intimated and it does not seem to igniting any fire in the midterm campaigning. Sure the usual suspects continue to mention it, but it does not seem to be resonating widely.

ISSUE #4: It’s the Economy Stupid. The stock market says it all. As the mother of all economic indicators, the stock market is voting thumbs up on the economy. Sure there are weak spots – nothing’s perfect – but economic conditions are clearly positive and improving and a great deal better than they were 5-6 years ago. Whether Obama had anything to do with it or not, it reflects positively on his administration and the Democratic Party. With the market virtually yawning at these four issues and pushing higher through it all, the likely impact on the midterm election will be favorable and boost the market in the near term and over the next several months.

How September options expiration week could trade

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Monday of September options expiration week is bullish for DJIA and S&P 500 although major shellacking’s in 2001 and 2008 pull the day’s average gain since 1982 negative. NASDAQ’s record is much weaker on Monday, declining 20 times in 32 years. Moving forward to September option expiration day, it is generally bullish and has improved recently with DJIA up eight of the past ten years with an average gain of 0.5%. S&P 500 and NASDAQ have nearly identical recent track records. Full-week performance has a somewhat spotty record over the last tens years for DJIA, up six and down four. However, S&P 500 and NASDAQ have fared better, both have gained in nine of the past eleven years.

Four-year cycle sweet spot, S&P 500 could top 2300

After breaking through resistance in mid-August and trading at new highs in early September, DJIA (almost a new high), S&P 500 and NASDAQ have lost momentum and have begun to drift slightly lower. Stochastic, relative strength and MACD indicators applied to all three indices have all rolled over, confirming recent weakness. Despite recent improvement, September is still the worst performing month and it is beginning to live up to this reputation once again this year. Average losses since 1950 for September are: DJIA –0.8%, S&P 500 –0.5% and NASDAQ (since 1971) –0.5%.

Historically speaking September weakness has been a great time to load up on stocks ahead of the “Best Six Months” of the year, November to April and an even better time in midterm years ahead of the best two consecutive quarter span of the four-year-presidential-election cycle.

The market’s sweet spot of the Four-Year Cycle begins in the fourth quarter of the midterm year. The best two-quarter span runs from the fourth quarter of the midterm year through the first quarter of the pre-election year, averaging 15.3% for the Dow, 16.0% for the S&P 500 and an amazing 23.3% for NASDAQ. Pre-election Q2 is smoking too, the third best quarter of the cycle, creating a three quarter sweet spot from midterm Q4 to pre-election Q2. Appling these average gains to yesterday’s closing prices puts DJIA at 19675, S&P 500 at 2315 and NASDAQ at 5656 at the end of Q1 next year. But, considering the markets recent run and the specter of rising interest rates, a mid- to high-single-digit advance is probably more likely between now and the second quarter of 2015.

Catching a falling knife

The British pound has a seasonal tendency to decline just ahead of the end of the third quarter and reach a bottom near mid-September (shaded in yellow). Then it typically rallies from October through the end of the calendar year. After that, the market starts to fade against the dollar again, before posting a bottom shortly before Britain’s fiscal year begins in April.

Seasonally speaking, the pound tends to trade higher in value against the U.S. dollar from about September 17 until about November 3. In the last 39 years this trade has worked 25 times, for a success rate of 64.1%. This trade has struggled in recent years, generating losses in four of the last six. However, it is setting up nicely this year with a sizable decline since mid-July and an almost panic-like selloff over the past few days over concerns that Scotland may split from the United Kingdom. Whether Scotland leaves or not (most likely not as a 47% to 45% poll margin is not all that convincing) is still up in the air. However, the magnitude of the British pound selloff certainly does look excessive and poised for a rebound especially if there is follow through on recent Bank of England Governor Mark Carney comments suggesting interest rates are likely to increase in the UK early next year.

Why crude oil is likely to head lower

Crude oil price tends to make significant price gains in the summer, as vacationers and the annual trek of students returning to college in August creates increased demand for unleaded gasoline. The market also tends to price in a premium for supply disruptions due to threats of hurricanes in the Gulf of Mexico. However, towards mid-September, we often see a seasonal tendency for prices to peak out, as the driving and hurricane seasons begin to wind down. Crude oil’s seasonal decline is highlighted in yellow in the following chart.

Shorting the February crude oil futures contract in mid-September and holding until on or about December 9 has produced 20 winning trades in the last 31 years. This gives the trade a 64.5% success rate and theoretical total gains of $72,890 per futures contract. Following three consecutive years of losses, this trade was successful last year as crude slid from over $103 a barrel in September to the mid to upper $90s.

Combining crude oil and liquids from natural gas, the U.S. is once again the world’s largest oil producer, greater than Saudi Arabia and Russia. U.S. crude oil production is forecast to reach its highest level since 1972 next year which is lowering U.S. imports and keeping geopolitical price pressures in check. Strong domestic supplies and a strengthening U.S. dollar suggest even lower prices for crude.

Seasonal trend signals trouble ahead for Apple

Next week Apple (AAPL) will unveil its latest innovations. Unfortunately, most of what will be revealed is already in the public domain thanks to various leaks and information available on Chinese telecom websites. This year we are all expecting a larger screen and improved speed. Battery life will likely remain about the same and sharp lines will likely give way to rounded edges (similar to the first iPhone). Apple has become as reliable as a quality Swiss timepiece in regards to when it unveils its new iPhone(s) in September which makes the following seasonal chart of Apple all that much more reliable.

In the above chart, a yellow box highlights weakness that occurs typically beginning in late August that lasts through early October. This seasonal dip is due to a few of nasty September market selloffs (2000, 2001, 2002 and 2008) and a few disappointing new product announcements. Based upon recent trading, it would appear Apple shares have already begun this seasonal slide. Absent a true surprise, that is well-received next week, further weakness is anticipated for the next few weeks.

Second week of September posts best market gains

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September has an ugly history for the market and is the worst performing month going back to 1950, but in recent years the record significantly better. The S&P 500 and Russell 2000 have been up 8 of the last 10 years with average gains of 0.9% (ranking #5) and 1.5% (ranking #4) respectively. NASDAQ and the Dow have been up 7 of the last 10 years with average gains of 0.9% (ranking #5) and 1.7% (ranking #4) respectively.

I stopped CNBC last Friday to the prospects for a market shake up in September on Closing Bell with anchors Kelly Evans and Brian Sullivan as well as Dan Greenhaus from BTIG. As we have argued recently, we expect the August lows to hold for the year and any mild pullback is most likely to occur toward the end of September and perhaps in infamous October.

But next week is clearly the best week of September. Our Monthly Strategy Calendar for September shows bull icons on everyday next week, which signifies the S&P 500 has been higher 60% or more of the time on each of those trading days. The entire second week of September bullish bias can be attributed to the fact that the week before options expiration week is up 13 of last 21 and 8 of last 10 for the S&P 500 with a 1.1% average gain for the week in the last 10 years. The Dow is up 7 of the last 10 years (1.1% average gain) during this week before expiration, NASDAQ 8 of 10 (1.1% average) and Russell 2000 7 of 10 (1.1% average).

Best & worst August ETF sectors

After suffering their first monthly decline in five months in July, DJIA and S&P 500 rebounded handsomely in August gaining 3.2% and 3.8% respectively. August 2014 handily outperformed the average August loss since 1950. For S&P 500, August 2014 was its best August performance since 2000 and the tenth best since 1950. NASDAQ and Russell 2000 also had a banner month with both indices climbing 4.8%. Strength was broad-based across ETF sectors with 27 of 29 sectors tracked posting a gain in August. Bear/Short and Currency sectors were the only decliners. Currency sector losses were due to U.S. dollar strength in August.

Top performing Almanac Investor ETF sectors in August were: Biotechnology/Pharmaceutical (9.0%), Semiconductors (8.2%), Leveraged Long (7.2%), Mid Cap (5.0%) and Healthcare (4.6%). Year-to-date and over the past 12 months, the Semiconductor sector has been the performance leader, up 23.7% and 43.4%. First Trust Amex Biotech (FBT) was the top-performing fund in August, up 14.5%. FBT was joined by PowerShares Dynamic Biotech & Genome (PBE), SPDR Biotech (XBI) and Market Vectors Biotech (BBH) on the 1-Month Winners list, all with double-digit gains in the month. In spite of recent weak economic data in Brazil, three Brazilian ETFs appear on the Winners list. Much of their gains can be attributed to speculation that the current administration may be ousted later this year at election time. PowerShares DWA Healthcare Momentum (PTH) and Market Vectors Vietnam (VNM) rounded out August’s best performing, unleveraged ETFs.

Market at a glance

This Market at a Glance originally appeared in an Investor Alert on StockTradesAlmanac.com.

Psychological: Complacent. Following a brief two-week dip, Investors Intelligence Advisors Sentiment survey is once again reporting bulls above 50%. After a few days above 15 in late-July and early-August, VIX fell back below 12 (until today). Both data points suggest traders and investors are either fully invested or quite close to it, possibly leaving little available cash for further purchases. However, this does not mean the rally is over, it only suggests that the pace of gains is likely to moderate. Absent an exogenous event driven shock, traders and investors could remain comfortably bullish for long periods of time.

Fundamental: Solid. It is all in the data. Economic reports may not be perfect and many are seasonally adjusted and then adjusted again, but U.S. GDP was 4.2% last quarter. The unemployment rate is 6.2%, down from double digits. The housing market is taking a bit of a breather, but was double-digit year-over-year gains really sustainable indefinitely? And corporate earnings are certainly solid with stock markets at or near new highs. Yes, numerous areas still need improvement. There always will be some weak or disappointing detail in the data, but broadly speaking the fundamental picture in the U.S. is rather firm.

Technical: Consolidating. After blasting through resistance last week and marching to new highs earlier this week, DJIA, S&P 500 and NASDAQ are taking a breather. All three are above their respective 50- and 200-day moving averages, but their rapid ascent has stretched Stochastic, relative strength and MACD indicators. Provided DJIA can hang out around 17000, S&P 500 around 2000 and NASDAQ around 4550 for a few trading sessions, the lows from early August are likely to hold for the rest of the year.

Monetary: 0-0.25%. Sufficient economic data exists to support a rise in the Fed funds target rate. Many areas of the labor market are solid (underemployment and participation rate excluded), inflation is running around 2%, overall economic activity, based on GDP, is solid and stock markets are making new all-time highs. However, many Fed members still appear reluctant to trim monetary support. Here’s hoping this isn’t the Fed’s next big monetary policy blunder.

Seasonal: Bearish. Since 1950, September is the worst performing month of the year for DJIA, S&P 500, NASDAQ (since 1971) and Russell 1000 (since 1979). Although September’s overall rank improves modestly in midterm years going back to 1950, average losses widen for DJIA (–1.0%), NASDAQ (–0.7%) and Russell 1000 (–1.0%). S&P 500’s average September loss improves slightly from –0.5% to –0.3% in midterm years.

Summer rally makes me feel fine

With all this bullish sentiment and new market highs we took a deeper look at the S&P 500 when August was up with respect to summer rallies, the Best and Worst Six Months and the remainder of the year. So far August 2014 is on pace to be in the top 15 Augusts since 1950. As August is the worst month since 1988 and averages -0.1% since 1950, the current 3.6% gain for the S&P stands out.

In the table above we show all the positive S&P Augusts since 1950 followed by the gain for September, October, the Summer Rally, the Worst Six Months, the rest of the year, the gain for the whole year and the subsequent Best Six Months. The current month-to-date August gain of 3.6% is in line with the average for up Augusts. Interestingly, there is no difference in September and October is weaker after an up August. There is a slight improvement in the summer rally and the Worst Six Months, but the rest of the year and the subsequent Best Six Months are weaker and the whole year is the same.

This history is supportive of our cautiously bullish current view. While we feel the recent August low will hold for the remainder of the year, expect some volatility over the next two months with another mild correction, then a solid market in November and December after the midterm elections.