Will These Stocks Rally Again This Year?

The US markets are on a roll as we head into the last quarter of the year. The S&P 500 continues to record new lifetime highs on a regular basis. While a section of the trading community has been skeptical of the rally, it has not deterred the bulls from buying on every dip. The correction still eludes the bears.

Key points

  1. The markets are at new lifetime highs.
  2. The fourth quarter is the strongest quarter for the stock market.
  3. Historically, five stocks of the Dow Jones industrial average have traded positive about 80% of the times in the fourth quarter.
  4. We analyze the charts of the five stocks to determine whether they offer a good risk to reward trading opportunity this year.

However, the current bull rally, which is already the second longest in history calls for caution but traders should continue to participate because no one can predict the exact top in the markets. It is only in hindsight that one comes to know about the top.

Therefore, in this article, we shall analyze the historical performance of the stock markets and a few stocks in the fourth quarter of the year, which have rewarded the investors handsomely.

Though it is not necessary that history will repeat itself, chances are that it may rhyme. These studies help the trader improve his odds for success.

The Dow Jones industrial average has risen for eight straight quarters, the longest winning streak since 1997. The S&P 500 has also rallied similarly, while the Nasdaq composite has risen for five straight quarters.

Though the September quarter is cyclically one of the weakest, this year, the Dow rallied 4.9%, the S&P 500 4%, and the Nasdaq composite 5.8% respectively. The stock market has entered its strongest quarter with a favorable tailwind.

The fourth quarter is the strongest for the markets

The fourth quarter is the best quarter for the stock markets by a huge margin. In the last 25 years, it has been positive 80% of the times. This is no small achievement. Also, the returns have been impressive.

Therefore, it is appropriate to expect the markets to close the year with strength. That is what most of the analysts also forecast.

Analysts expect 2017 to end on a strong note

In a recent poll by CNBC, majority of the analysts were confident that the S&P 500 will rise from the current levels and end the year with strength.

Along with the rise, they were extremely bullish on the pace of rise. About 79% believed that the rally will be more than 5%, which gives a year-end target of 2635 on the S&P 500. Considering the rally of the past few days, it certainly looks achievable.

But it is not only the US markets that are creating new records. The global stocks have also equaled the record for consecutive monthly gains – 11 straight months, last achieved in 2003, during the rebound from the dotcom bust.

Therefore, historical evidence suggests that we should see a strong fourth quarter, which will be good for stocks.

However, in the current bull run, the rally has not been broad-based. Only a handful of stocks have led the rally. Therefore, in order to profit, one has to pick the right stocks. Just buying any stock in the markets will not guarantee returns.

A study by CNBC  has identified five stocks in the Dow Jones industrial average, which have rallied in the fourth quarter majority of the times.

While these are positive numbers over a long period of time, still, before investing, it is always prudent to analyze whether the performance can be repeated this year.

Let’s look at the chart patterns to find out whether the stocks offer a good risk to reward trade opportunity or not.

UNH

The stock is currently trading within an ascending channel. It has traded in the upper half of the channel for most of the times, however, in September, it fell to the lower end of the channel. Since then, the stock has again rallied back to the highs. We can expect the stock to continue trending higher until it breaks down of the channel. Therefore, we have a clear stop loss at around $190.

Also, considering the stock’s performance of the past few months, we can expect a rally to the upper end of the channel, which should be around $207. However, for that, the stock will have to first rally above the highs of $200.76. If we buy at the current levels, our immediate profit objective is around $10, whereas, the possibility of a loss is $8, which leaves us with a risk to reward ratio of 1:1. Traders can take 50% position at the current levels and add the remaining 50% once the stock breaks out of $201. The initial stop loss should be kept at $190, which should be trailed higher once the stock moves up.

HD

The stock has broken out of an inverse head and shoulders pattern, which has a pattern target of $176. However, most breakouts retest their neckline, which in this case would be the $162.5 levels. Therefore, traders can buy 50% of the position at the current levels and 50% on a retrace to $162.5.

The stop loss should be kept at $159 levels, just below the neckline because the pattern weakens when the stock starts to trade below $162. This gives us a risk to reward ratio of roughly 1:2.

CSCO

Weekly chart

The stock has formed a large base after falling from the peak made during the dotcom bubble. A breakout of the overhead resistance zone of $33 to $35 can be very bullish for the stock, as it has no major resistances ahead. Therefore, we can assume that the stock will gain momentum once it sustains above $35.

Daily chart

On the daily chart, we find that the stock has a stiff resistance at $34.5, where the stock is likely to stall its current rally. However, if the stock breaks out of the resistance, it will be very positive for it. Therefore, traders should wait for a close above $34.5 and enter at $35. The stop loss for the trade can be kept at about $32.5 levels. The rally can easily extend to $39 and higher, which gives it a risk to reward ratio of about 1:2.

DIS

DIS is range bound between $90 and $120. Currently, it is trending down, as price is quoting below the downtrend line and the 50-day simple moving average (SMA). Any rally from the present levels is likely to face a slew of resistances between $101 to $106, from the 50-day SMA and the downtrend line. Therefore, we don’t find a buy setup here that can be traded.

TRV

The stock has been in a well-established uptrend, trading inside the ascending channel since 2010. However, at the current levels, the stock is right in the middle of the channel. Its support is at $110, whereas, it has resistance at $130 and thereafter at $140. The stock has not reached the upper end of the channel since November 2015. Therefore, the chances of a rally to the upper end of the channel in the fourth quarter look dim. At the present levels, we don’t find a good trade setup, which offers an attractive risk to reward ratio.

Conclusion

After analyzing the charts of the five stocks, we find buy setups only on three stocks. We don’t find any reliable buy setups on the other two.

Though the fourth quarter is the strongest, October gives jitters to the history students of the stock markets because two major crashes started in this month. First was the crash on 29 October 1929, commonly known as ‘Black Tuesday’ and the second was the crash on 19 October 1987, also known as ‘Black Monday’.

Though we don’t expect a similar crash this year, there is no running away from the fact that the markets are trading above their average price to earnings ratio. Additionally, the geopolitical tensions and the news on the tax reforms will keep the markets on the edge. Therefore, traders should be cautious and reduce their position size. Participate in the markets but with a lower allocation and keep a generous amount of cash in the portfolio.

Author:
Rakesh Upadhyay is a Technical Analyst and Portfolio Consultant for The Summit Group. He has more than a decade of experience as a private trader. His philosophy is to use technical analysis for momentum trading and fundamental analysis for long-term positions. Rakesh likes to keep himself fit by lifting weights and considers himself to be a spiritual person.