Wednesday, May 4, 2016

The More Things Change, The More They Stay The Same

The following is a passage from "The Panic of 1907: Lessons Learned from the Market's Perfect Storm" (Bruner & Carr).  If you didn't know any better, you could have picked up a random newspaper off a bench this morning and assumed it was written to describe present-day America:

"Americans had become increasingly disturbed by the tumultuous changes that had accompanied the country's impressive industrial growth.  They were worried about the number and type of immigrants entering the country; the size, noise, and frenzy of the nation's large cities; the effectiveness of their elected representatives; the consequences of old age, illness, and injury on the job; the day-to-day hazards of urban life; and even the quality of their food and water.  Yet most of all they reacted with alarm to the rise of big business and the corporate merger movement.  Some Americans, calling themselves "progressives," argued vociferously for the right of a community to protect itself against those who pursued their economic self-interest without concern for the common good."

If, like us, you're a student of history, you know that patterns have a way of repeating themselves and that's why we like to look at charts, data, and trends from year's past to help assess the current market landscape.

With this thought in mind, we thought we could offer up a couple of interesting settings/conditions playing out right now that evoke memories from past market periods.  We've got a couple of incredibly bullish data points and a few bearish stats as well.

Bullish Potential

We looked at data going back to 1950 and found that the S&P 500 finished April with a peak to trough range of just 17.23% (using monthly closing figures).  That's 760 months worth of market history and the 2-year period that just concluded (April 2014 - April 2016) featured one of the tightest S&P ranges that we could find.

Knowing this, we then wanted to look at forward returns after similarly narrow 2-year consolidations.  The results are exceptionally bullish looking out 1 to 2 years and mildly bullish over more intermediate-term spans.

What we found is that there have been six 2-year periods since 1950 where the market stayed within a 20% peak to trough range.  After the S&P broke free of those ranges, it moved significantly higher on average with 1-year returns being 16.6% with an 83% success rate.  And average 24-month returns being nearly 35% with a 100% success rate.  These numbers come in well ahead (nearly double) of the results when you consider all days from 1950-2016.

Looking at the chart below, we admit that the sample size is small and it's hard to draw confidence from such infrequency but we still found it interesting that the trend has resolved to the upside every time after similar long, tight consolidation phases.

*Please note that one reason the sample size is so small is that we eliminated all months within the same 2-year span except for the final month before the S&P staged a break out.  There were 27 total instances but we did this to reduce redundancy.*

This study is complimented with some recent work done by Steve Deppe, of Nerad & Deppe Wealth Management, that analyzed instances where the monthly Bollinger Bands on the S&P had squeezed to a width of less than 15.  Bollinger Bands essentially measure volatility by looking at price highs and lows over a given time period.  Deppe looked at the last 20 months of S&P data and found that the index had demonstrated very little volatility over that span and even less when considered within the context of market history.

He noted that at the end of March the S&P's BB width sat at 11.53.  Meanwhile, since 1970, the average monthly BB width has registered at 33.2, nearly 190% greater than where March closed.  His chart below shows the results of when the monthly BB width squeezed to below 12 from 1970 onward.  The forward looking results are overwhelmingly positive.

Bearish Potential

When weighing the current evidence, bears are quick to point out that we are heading into, historically speaking, the worst stretch for the market in terms of seasonality.  It's well known that the next 6 months have routinely been the market's toughest, hence "Sell in May and Go Away."

We can add further fuel to the bears' fire by dusting off a resource we highlighted several months back.  This work comes by way of market analyst Wayne Whaley and Steve Deppe again.  We were first introduced to Whaley's "TOY Indicator" and its remarkable success rate by Deppe back in the fall and again in January.

In short, Whaley looked at the S&P going back to 1950 and found that the two month window, November 19th to January 19th of the following year, had a striking accuracy in calling the performance of the following 12 months.  TOY stands for Turn Of the Year since the indicator covers November to January.

And in a recent note, Whaley went even more in-depth and highlighted that when the TOY Barometer was negative (as it was from November 19th, 2015 to January 19th, 2016), the traditional "Sell in May and Go Away" period (May 5th - October 27th) was positive in only 2 out of 14 instances and lost an average of 9.55% (with a median loss of 9.21%)  Terrible odds, poor results and not very comforting as we head into the summer months.

Whatever your bias in this environment, you can certainly find the data and the anecdotes to back it up.  Have a good evening.

Ryan Worch is the Managing Director of Worch Capital LLC. Worch Capital LLC is the general partner of a long/short equity strategy that operates with a directional bias and while emphasizing capital preservation at all times.

Ryan on: Ryan Worch on LinkedIn, Ryan Worch on Twitter | Ryan Worch Bio