Stock markets were on fire last year, to the surprise and dismay of many, who, for any number of reasons, were scared to the sidelines.
Who enjoyed last year’s stock market gains?
Not many everyday folks, I suspect, as investors have collectively pulled money out of U.S. equity ETFs and mutual funds in seven of the last 10 quarters.
Yet, despite growing numbers of both bubbly markets and global risk factors, stocks were actually a really good bet in 2017.
All four major U.S. stock indices closed higher. And if you ventured into foreign stock markets – as I suggested here and here – you could have done even better.
“But what about next year?”
That’s the question of the moment.
Well, next year is very likely to be another good one for stocks… particularly U.S. stocks.
Sound wild? Well, that’s simply what the data tell me.
You’re probably seeing a lot of three things this time of year:
exercise equipment commercials, and
financial market predictions and forecasts.
All three tap into everyone’s desire to “be my best” in the New Year. And all three require you to temper wild claims with a healthy dose of common sense.
So here goes.
It may seem like a cop-out for me to simply say stocks are likely to have a good year in 2018. It’s neither a bold prediction nor a precise forecast.
But, as a colleague of mine noted, “Adam isn’t a ‘forecast’ guy.”
Part of it is simple recognition of my limitations – particularly when it comes to “seeing” things in the future.
More importantly, future outcomes, for me, are all about probabilities, never certainties.
Probabilities can go a long way in helping us know what to expect from financial markets. Probabilities also give us reason enough to overcome the kind of fear that keeps some people out of the game.
Let’s start with the base-case statistics for stocks…
Since 1950, the S&P 500 has produced positive returns in 72% of calendar years.
It’s been even more consistent since 1980, producing up-years 79% of the time.
No matter how you slice the data, equity markets are bullishly biased.
If you could only make one directional bet (bullish or bearish) at the start of every calendar year, you’d do very well always betting on the bullish side.
Doing so doesn’t make you a “perma-bull.” And it doesn’t mean you’re “ignorant” to the risks inherent in risk assets. It simply means you understand and respect the base-case statistics, which strongly support the likelihood of higher equity prices in a majority of years.
But there’s another reason I expect 2018 to be a great year for U.S. stocks, in general, and for a small handful of stock sectors, specifically.
Always the Bridesmaid, Never the Bride
Momentum strategies, like the one I use in Cycle 9 Alert, rely on the tendency for strongly appreciating assets to continue appreciating – at least long enough for momentum investors to profit from the continued bullish trend.
This effect is seen in the so-called “Bridesmaid Strategy,” popularized by institutional research firm The Leuthold Group.
The idea is simple: to forecast next year’s top-performing asset class, look at the past year’s second-best asset class (aka “the bridesmaid”).
The Leuthold Group’s research shows you can beat the average stock market return by 4.8% a year, by simply buying last year’s runner-up.
I’ve tallied and ranked the 2017 performance of the seven major asset classes considered:
As you can see, the S&P 500 earned the “bridesmaid” spot in 2017, making it the best bet for outperformance in 2018.
This simple concept also applies to a smaller subset of investments – the nine U.S. market sectors.
This doesn’t surprise me one bit, of course, since I developed Cycle 9 Alert six years ago to take advantage of momentum effects within U.S. stock sectors.
Again, all you need to do to hone in on next year’s top contender is identify last year’s second-best investment.
Here’s a ranking of U.S. sectors in 2017:
The materials sector (XLB) officially earned the No. 2 spot, although the industrials (XLI) sector was just a hair (0.2%) behind.
Interestingly, materials and industrials are closely related – both are components of the global manufacturing and construction industries.
The Bridesmaid Strategy suggests the No. 2-ranked sector tends to outperform the S&P 500 by an average of 3.9% over the following year.
So here’s my forecast for the New Year:
- S. stocks are statistically likely to close 2018 higher,
- S. stocks are statistically likely to outperform all major asset classes in 2018, and
- the materials and industrial sectors are statistically likely to beat the S&P 500 in 2018.
None of these are guarantees, mind you. I don’t even know if we could call them “forecasts” or “predictions.” And they certainly don’t paint a “wild” picture.
But that’s fine.
My Cycle 9 Alert readers have long proven you don’t have to “see the future” in order to be an extraordinarily successful active investor.
Exploiting favorable odds, in momentum, is more than enough.
The content of our articles is based on what we’ve learned as financial journalists. We do not offer personalized investment advice: you should not base investment decisions solely on what you read here. It’s your money and your responsibility. Our track record is based on hypothetical results and may not reflect the same results as actual trades. Likewise, past performance is no guarantee of future returns. Certain investments such as futures, options, and currency trading carry large potential rewards but also large potential risk. Don’t trade in these markets with money you can’t afford to lose. Delray Publishing LLC expressly forbids its writers from having a financial interest in their own securities or commodities recommendations to readers.