Will Investors Be Satisfied With 10% In 2021?

There are only seven full trading days left in 2020, and the focus for many investors is on what will happen to stocks and the economy in 2021. As for the economy, most are looking for a rough first quarter, followed by a good rebound for the rest of the year. This is based on the hopes for additional government stimulus and a successful rollout of vaccines. Economists in a recent survey gave average expectations of 4.4% GDP growth in 2021.

December is when the strategists from all the major Wall Street firms provide their prediction for where the S&P 500 will be at the end of the following year. On average they are looking for a 9.5% gain by year-end of 2021. Each year there are also typically several articles about how poorly their past forecasts have matched up with reality. The forecasts for year-end 2020 were of course made before the COVID-19 pandemic, which no analyst predicted. However, that is the problem with the whole exercise, as during a year, anything can happen.

As one can see there is a wide range in the individual forecasts for 2021, with a low prediction for the S&P 500 of 3800 and a high prediction of 4400. The S&P 500 closed Friday at 3709.4, up 14.8% year-to-date. For 2020 the low forecast was 3100, with a high of 3700. The median forecast was for a 2.7% gain, which means that despite (or perhaps because of) the pandemic, the S&P 500 wildly outperformed estimates this year.

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Since these forecasts are accompanied by an estimate of S&P 500 earnings for the year, it is clear that they are based primarily on fundamental, not technical, methods of analysis. Technical (or chart) analysis is based on buy and sell decisions that have already been executed in the marketplace. Fundamental analysis is generally based on a company’s estimate of future earnings, which includes assumptions about the consumer’s demand for their product that may or may not hold true. I decided early in my career that forecasts based on past behavior were much more reliable.

In addition to the price behavior of the major averages, I look at the cumulative analysis, the number of stocks or issues advancing and declining. This is represented by the advance/decline line. It is my view that this cumulative picture allows one to determine the internal health of the market on a monthly, weekly and daily basis. This is not a view that is shared by all analysts.

The Nasdaq 100 NDAQ advance/decline line is one of the six I follow across all time frames. The monthly chart of the Invesco QQQ Trust (QQQ) QQQ is plotted above this A/D line (in red) with its 21-month weighted moving average (WMA, in green). The last major signal occurred in March 2016, when the monthly A/D line overcame resistance (line a) and made a new high (point b). The monthly A/D line since then has never dropped below its WMA, not even in 2018 or 2020.

As I pointed out in October, when I looked at the weekly NYSE All-Issues A/D line action prior to and after the last four presidential elections, the A/D analysis held true before and after each of those elections, despite some volatility for a few weeks on either side. That was also the case this year, as in the article I commented that “the advance/decline analysis indicates that new highs are likely before the end of the year”.

The Nasdaq 100 has been the strongest market since 2016, and based on the month/y and weekly analysis there are no signs that this is changing. The weekly chart shows that a triangle, or flag, formation (lines c and d) was completed on a closing basis at the end of November. 

These are what is known as continuation patterns, periods of pause in a major up- or downtrend. The shape of the pattern can be used to generate price targets, which in this instance range from $335 to $350. However, I can’t rule out a 5-10% pullback on the way to these targets. The weekly starc+ band is currently at $327.17.

The weekly Nasdaq 100 advance/decline line moved to a new all-time high the week ending June 5, 2020 (line b). A similar bullish signal was generated by the S&P 500 A/D line in early August. The Nasdaq A/D line turned sharply higher last week and is now well above its rising WMA. The daily Nasdaq A/D line (not shown) has been above its WMA and positive since November 3.

From the charts of the QQQ, it is not surprising that the Nasdaq 100 gained another 2.9% last week and is now up 45.9% year-to date (YTD). It was also another strong week for the iShares Russell 2000 (IWM) IWM which was up 3%, and has exceeded its weekly starc+ band for the six week in a row. This high-risk reading makes it the most vulnerable of the averages.

IWM is now outperforming the Dow Jones Transportation Average, S&P 500, and the Dow Jones Industrial Average. If the strategists are right about a 9.5% yearly gain, I think the majority of new traders and investors will not be satisfied, as they have grown accustomed to stocks that can double in just a few months.

The explosion in IPO stocks has not helped quell the high level of bullishness. As of this morning, it now seems that there will be a stimulus bill before the end of the year. The market has been counting on such a bill for several months, and while it could trigger even more buying, it might not. I would continue to protect trading profits with trailing stops.

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