With the "Brexit" decision looming over markets last week we got a fresh reminder of just how tightly asset classes are correlated when the market receives an unexpected shock. This was the case when Britain, to the surprise of most, voted to leave the European Union. US government bonds, the dollar, Yen and precious metals all soared higher while global stocks, the Euro and oil got hit hard upon the outcome of the vote.
VIX Term Structure:
Since the start of this sideways, choppy market environment in late 2014 when the VIX term structure has gone above 1 that has been a short term buying opportunity. Will this time be different??
Below is an excerpt from our latest monthly letter to investors & friends that we think sums up the current state of affairs:
one were to give a theme to the market action and data points we saw over the
course of May and so far in June, the word indecision would play
well. In early May, it was all but a given that the FOMC and Chair Yellen were
not likely to touch interest rates until much later in the year and fed funds
futures prices were reflecting that belief. As the month carried on though the
market seemed to make an about-face after a number of Fed officials came out
and suggested that an increase at their June policy meeting could be warranted.
In fact, the minutes from the committee’s April meeting (released in mid- May)
echoed that same sentiment:
participants judged that if incoming data were consistent with economic growth
picking up in the second quarter, labor market conditions continuing to
strengthen, and inflation marking progress toward the Committee's 2.0%
objective, then it would likely be appropriate for the Committee to increase
the target range for the federal funds rate in June."
a result, over the course of a week the fed funds futures market’s probability
of a June rate hike jumped from 8% likelihood to over 30%. And the likelihood
of a July increase leapt all the way to 55%. And the market appeared to cheer
all of this news as it coincided with the rally that held through the end of
May and into the beginning of June. Then we got the latest Non-Farm Payroll
report on Friday, June 3rd and it was a real
stinker. Only 38,000 new jobs were created versus an expectation of 170,000.
The April and March numbers were also revised lower by a total of 59,000 jobs.
These developments left the trailing 3-month job creation average at 116,000
versus the 12- month average of 212,000 jobs. Not exactly a glowing endorsement
of the economy or the Fed’s hope to move forward with a near-term rate
increase. And now with the June Fed meeting having come and gone, we know that
the jobs report along with other recent economic data was enough to push off a
rate hike until July at the earliest.
the Fed has been doing its job of throwing more confusion into the crowd,
there’s been a clear ramp in volatility over the last several days. In fact,
the VIX aka the fear index made a near 60% surge over the course of the last
week. One could have normally expected the market to wilt in the face such
increased volatility yet the S&P was down less than 1% over that span. This
stands in complete contrast to historical precedent as the market has averaged
a drop of nearly 7% when the VIX has risen 55% or more in a given 6-day period.
In addition to the Fed’s lack of movement, the rise in volatility has been
aided by investor nervousness in advance of the “Brexit” vote (the British
referendum to exit the European Union). It appears investors are doing their
positioning on whether Britain will stay or leave via the options market and
this has made the VIX even more spastic.
thing is clear, when we examine the chart below we see that the market has held
a great deal of angst ever since the end of QE3, onward through the first rate
increase in December 2015 and to present day as we wait to see what will
finally push the Fed into action for rate hike #2. There’s been essentially
zero price progress made by the S&P in the last 18 months.
besides the charts, there are plenty of other data points that show the level
of indecision held by investors and fund managers right now. Bank of
America/Merrill Lynch’s latest global fund manager survey shows that despite
corporate bond prices and US stocks being at or near all time highs, there
appears to be great amount of unease. In fact, BAML’s June measure of fund
managers’ allocation to cash in their portfolios was at its highest mark since
the post-9/11 panic in November 2001. Higher even than at the depths of the
2008-2009 financial crisis. At the very least, this measure shows that fund
managers worldwide are simply running out of ideas for where to invest capital
and would rather hold cash. Couple that with the survey’s respondents voting
“long quality stocks” (think US Large Caps) as being the most crowded trade and
you get a better idea of just how hated the recent moves of the S&P 500
might be. But be aware, these data points have a tendency of being contrarian
in nature. BAML’s measure of fund managers’ cash levels sits at 5.7%. It was at
5.6% during the year-to-date lows in February and the S&P proceeded to
rally 17% from that level. The same goes for November 2001, which was not a
bear market low, the S&P managed to rise 10% over the next 2-months. The
difference today being that we’re within earshot of all-time highs yet cash
levels are abnormally high.
There's been much talk lately about the length of time that the S&P 500 has now gone without making a new high. In fact, May 19th marked the 252nd consecutive trading day (equals one calendar year) in which the index had gone without registering a new high mark. With the S&P now just 70bps (currently 2,118) away from eclipsing its all-time high of 2,134, we wanted to look at past instances where the index had gone at least a calendar year without setting a new peak and how it performed once it did gain new high ground.
Going back to 1950, there have been 13 instances where the S&P went at least 252 trading days without making a new high. However, once the index has been able to gather the steam to breakout to the upside, the forward looking returns have been rather encouraging. We looked at 1, 3, 6 and 12-month returns and the average, median and max performance are all very strong and can be seen in the table below. S&P 500 Performance: When Index Goes At Least 252 Trading Days Without New High
We then took the study a step further in an effort to account for the environments in which these moves occurred. By our count, 9 of the 13 episodes happened in the midst of secular bull markets. As you can see in the stats above, the average returns for those periods alone are even more powerful with forward 12-month returns sitting at nearly 18%.
In the 4 occasions where the index took at least 252 trading days to make a new high while in a secular bear market (end dates: 1972, 1980, 2007, 2013), the average performance, while still positive, was much weaker than the total sample size. Forward 12-month returns averaged just 3.28%. Also note the huge divergence in time taken to make a new high between secular bulls vs bears.
We've shared some charts of the secular bull/bear periods for the S&P and Dow below for further reference:
If stocks are able to stay firm here and make a sustained push through the 2,130 level, history suggests that favorable odds for further gains could be in the offing. This would be a nice set of data for bulls as they seek to combat all of the negative seasonal conditions that are prone to occur in the summer months aka Sell in May & Go Away...
In looking at many of the recent sentiment and participation measures it's easy to see that very few investors had anticipated or positioned for the market to be testing new highs. Particularly given that markets were making fresh 12-month lows just a short time ago in mid-February. But perhaps there's more time to participate in this latest up-move. Jason Goepfert of SentimenTrader noted in Barron's over the weekend that, going back to 1928, there have been 14 years in which the S&P posted 3 consecutive months of gains after making a 12-month low (which is what we had this year where 12-month low made in February and then March, April, May all logged gains). In 12 of those prior 14 years, the market continued rally for at least another 3 months.
"Goepfert sees parallels between now and 1953, when stocks underwent a minor correction after a multiyear bull market. Then, as now, the advance/decline line hovered near its all-time high and market breadth was strong. Mimicking 1953 would be the best of all scenarios: The S&P rose 24.7% in the nine months following the 3-month signal and went on to return 83.8% two years out."
We're not quite ready to be that optimistic but the market has certainly flashed some encouraging signs as we head into the historically challenging summer months.
The month of May was a positive one for stocks as the S&P 500 was up just over 1.5% while the NASDAQ lead the way with an impressive 3.62% gain. And after 5 months, the S&P is now up 2.70% for 2016.
Looking ahead to June, the last month of the 2nd quarter, we took a quick glance at what the month the typically has brought in terms of performance over the years. What does the average June look like? Data going back to 1950 shows that June:
Is the 3rd worst month of the year
Averages a loss of -.05%
Only higher 50% of the time
Average drawdown from May close is -2.96%
Average draw-up from May close is 2.90%
The 3-month period of June-August is the 3rd worst from a seasonality standpoint since 1950 for an average gain of 0.28%
In the last 10 years June is ranked the worst month with an average loss of 1.53%. June-August also ranks as the worst 3-month stretch with an average loss of 0.21%
In the last 20 years this is the average daily fluctuation in the S&P in June. Volatility really picks up in the second half of the month.
When we throw some filters (some of today's current conditions) on June the numbers continue to suggest weakness.
When the prior month (May) was positive
When the rolling 3-month period was positive
When YTD the S&P is up
June is still weaker as it is the 4th worst month but goes from an avg loss of -.05 to a gain of .37%
Bullish sentiment rebounded strongly from last week’s extraordinarily
low reading, but still remains well below its historical average. At the
same time, neutral sentiment remains at an unusually high level despite
falling significantly this week.
Lower end of range and term structure still towards lower levels.
A/D line at new highs which is encouraging
What's interesting is short-term (10 day) and long-term (200 day) the participation rate is also encouraging. However the % of issues trading above their 50-day moving average is showing a clear divergence as the S&P is testing April highs.
New 52-week highs measure is lagging this current move as they peaked out in early April
Clearly the jobs number from Friday was very weak and we continue to operate in a slower growth environment. The weak report puts the odds against a raise at the June Fed meeting as it put downward pressure on the dollar and treasury yields which eventually could bode well for the equity markets.
The weak jobs report on Friday could be used to work off some overbought conditions in the market as we enter a seasonably weaker period while giving some breadth measures a chance to catch up. With the combination of many investors having a neutral stance on the market, lots of cash on the sidelines, the monthly bollinger band squeeze, and the potential for a weaker dollar, we could have proper conditions for the market to breakout to the upside in the coming months.