First of all, I want to say that the purpose of this post is not to make predictions about the future, so if you’re expecting a 12-month price target for the S&P 500, you’ll want to look elsewhere.
Throughout this exercise I used the weight of evidence present in markets around the globe in order to identify some market themes that I think will occur throughout 2016. Lastly, I want to say that none of these market themes are set in stone. As a market participant, I’m not here to be right/wrong, if/when the weight of evidence changes I’ll adjust.
Without further adieu, here are the nine market themes for 2016.
1. Developed > Emerging Markets
Since the SPY / EEM and VEA / VWO ratios bottomed in 2011, they’ve been on a complete tear, representing the broad outperformance of stocks in developed markets over emerging markets. These ratios developed multi-year bases and the breakouts from them were quite explosive. Despite their aggressive rallies, there is little evidence that suggests they’re ending anytime soon. There is evidence however, that their progress may be due for a bit of a pause in 2016.
The SPY / EEM ratio is approaching the 38.2% retracement of the 2000-2010 decline, which also corresponds with prior support near 6.7. In addition, momentum has negatively diverged at the recent highs, which has preceded pullbacks or consolidation periods in the past. Structurally this uptrend looks great, but we may see some consolidation this year before it breaks out to new highs.
Similar action is occuring in VEA / VWO as it approaches the highs it made in 2008. Despite the strong structural uptrend, momentum recently diverged as the ratio made new highs, suggesting a pause may be needed. Our structural target remains the 2008 highs, which also corresponds with the 161.8% extension of the 2014 correction. Despite this continued outperformance, I’d expect to see some consolidation in this ratio before it makes new highs.
2. Large-Caps To Outperform
Over the past decade or so, the ratio of large caps stocks to small caps stocks (SPY / IWM), has been forming a major base and is starting to break out of it. If the ratio can clear 1.80, then 1.95 is the next big level of resistance. If this ratio can eventually get above 1.95 there is room for a lot of potential upside. I’m going to continue to watch this chart throughout the year as I think this may be the start of a much larger / longer-term trend. And this could be one of the major market themes for this year and perhaps years to come.
3. Commodities As a Group Will Continue To Slump
This doesn’t necessarily mean another big down year for the group, it could very well mean a flat year. Many of these markets in strong structural downtrends or trendless markets, meaning that time will be needed for them to reverse / sustainable uptrends to develop. That doesn’t mean that there won’t be counter-trend / mean reversion opportunities to take advantage of over the year, but it does mean that we shouldn’t be expecting strong multi-year downtrends to reverse themselves in a relatively short period. Time heals all wounds, even in markets, but we have to be patient to allow sustainable trend reversals to take place.
A good example of this is Crude Oil. Many commodity charts have been more or less crashing below downward sloping 200 day moving averages for years. Sure, some counter-trend opportunities presented themselves in 2015, but the structural trend is still in place and will take weeks / months / years for these trends to change.