Conventional wisdom states that in the final year of a bull market, slow-growth large cap stocks should outperform and high-flying “pigs” should start to turn down. In other words, the previous leaders are now the laggards, and the previous laggards are now the leaders.
The Dow Jones has outperformed the S&P 500 year-to-date in 2017 by 5.5%. What happens historically when the Dow outperforms the S&P by at least 5% from January 1 to December 31 (i.e. first and last trading day of each year)?
Here are the 9 historical cases
We can immediately eliminate the 2002 and 2001 cases. Those occurred when the U.S. stock market was already in a bear market. Large cap stocks tend to fall less during bear markets, so it’s natural that the Dow outperformed (fell less) in 2001 and 2002. Let’s examine the other cases.
After making a “significant correction” (as defined by the Medium-Long Term Model) in 2011, the S&P did not make a significant correction in 2012.
The S&P went up 11.6% in 2012. It experienced 2 “small corrections”: one of 10.9% and one of 8.8%. In short, 2012 was a choppy year for the S&P 500.
2011 was unlike 2017. The S&P experienced a significant correction in 2011. It has not experienced a significant correction in 2017.
The bull market topped in March 2000. This case does not apply to today because the Medium-Long Term Model foresees neither a significant correction nor a bear market in 2018. This is based on data today. The model’s results change as the data changes.
The S&P increased 31.6% in 1997 and experienced 3 small corrections: 10.2%, 7.3%, and 13%.
The S&P made a significant correction in 1994. This case does not apply to 2018 because the Medium-Long Term Model does not foresee a significant correction.
The S&P made a massive “significant correction” in 1987 (the infamous crash of 1987). This case does not apply to 2018 because the Medium-Long Term Model does not foresee a significant correction.
The S&P continued to rally until September 1976, when it began a significant correction. In the meantime, it made a “small correction” of 6.3%. The S&P went up 18.2% from the beginning to end of 1976.
This case does not apply to today. The S&P had already begun a significant correction in August 1959, which lasted until October 1960. The S&P is not in a significant correction right now. It is making new all time highs.
The results from this study are all over the place. But there is one distinct conclusion that we can draw from this study. When the Dow outperforms the S&P by at least 5%, the U.S. stock market at least experiences increased volatility next year. In other words, 2018 will be nothing like 2017. The U.S. stock market will probably go up, but in a much more choppy fashion. Study after study has come to the same conclusion.
I think the most likely scenario is:
The S&P makes a 6%+ “small correction” in Q1 2018, followed by a new high, and then a big consolidation in the second half of 2018.