A Look Ahead To April

Looking Ahead

• Last 20 years: April is the best month of the year with an average return of 2.01%
• Last 20 years: The average April has rallied strong after tax day into month-end
• Since 1950: April ranks 3rd in monthly performance with an average gain of 1.46%
• The full year average gain is roughly 20% when January, February and March are all positive (note: The S&P officially closed March just barely in negative territory after a late day pullback on Friday)

Areas of Note

One area we're watching is the VIX term structure.  It is trading at the highs of the year but not yet at extreme levels.  While the VIX has been dormant thus far in 2017, it recently started to move higher as the market has pulled back.  The ratio below plots the VIX vs VXV.  When this indicator is rising it is telling us that the current volatility (VIX) is rising faster than the 3-month volatility (VXV).  Essentially it is another fear and greed measure.

The S&P hit a new all time high on the first trading day of March.  Since then it has pulled back and consolidated for the entire month.  This consolidation helped to work-off the excessive overbought readings created on March 1st.   The S&P corrected -3.25% from peak to trough in March while also breaking the uptrend line from the November lows.  However, the gap down on Monday (3/27) held support at the 50-day moving average.

The historical data shown above is quite favorable for April with tendency being for the market to rally into month-end after April 15th.  The current consolidation has served to work off excessive conditions while setting the table to resume higher.  At some point this market is poised for a bigger sell-off than 3.25% but we just may have to wait a little longer. After being defensive for much of the last month, the current pullback has allowed us to put some money back to work as the market attempts to re-take recent highs.

Some Alarming Contrarian Indicators

In our last post we stated that while the market remained in a sustained uptrend, we'd noticed some indicators that had started to flash caution signals.  Today, the Bank of America-Merrill Lynch monthly global fund manager survey (FMS) was released and it comes at the appropriate time as the market is experiencing its biggest down day of 2017.

There are some data points in the survey that serve as contrarian indicators and others that highlight potentially crowded trades.  To top it off, the S&P is currently breaking the uptrend line from the pre-election lows.  Are we finally getting the pullback that everyone has attempted to predict?  Lets get to the facts...

Below is the summary of the FMS survey straight from BAML:

"Bottom line: March FMS shows investor sentiment in a “bullish holding pattern”; cash can fund H1 upside but FMS Positioning & Profits argue for March/April risk rally “pause”; Policy the key catalyst for “Icarus trade” to fly higher in coming months."

These are some of more interesting data points from the FMS:

Crowded Trades:

• The 2 most crowded trades are long dollar and long banks
• The dollar has a potential bearish head and shoulders top while challenging the uptrend line from 2016 lows.  
• Banks via the KBE index are rolling over as they took out the Jan 2017 lows and are now negative on the year.

Rotation

•  Fund managers favor Emerging markets over US and more defensive sectors (utilities & staples) over more volatile sectors like energy.

Equities Overweight:

• Equity overweight is highest in almost 2 years
• However allocations to US equities dropped sharply to net 1% OW from net 13% OW last month.
• As we see above money has rotated to Eurozone as equities rise to 11 month highs to net 27% OW

Overvaluation

• While this measure can stay extended for long periods it is flashing contrarian readings favoring a pullback in the US dollar.
• The second chart confirms why fund managers are rotating into EM equities vs. US equities.

Summary

Fund mangers seem to be rotating into undervalued markets and defensive sectors.   The pullback today in financials flashed a perfect contrarian signal as it was the second most crowded trade.  The S&P 500 is having its first 1% down day since October 11th, 2016.  That represents 109 trading days since the last 1% drop.  This coincides with a break of the clearly defined uptrend from the election lows.  We have been raising cash the last few weeks because the evidence didn't suggest being too aggressive at current levels.  However, we maintain that this is a bull market and pullbacks after a sustained run are normal and should be looked at as buying opportunities. 

What's On Tap?

The S&P continues to operate in a strong uptrend.  While momentum may have stalled a bit since the March 1st high, the overall trend remains healthy.  A longer-term chart shows that the S&P has broken to the upside of a huge wedge pattern.  The question is: does this propel the market higher or could it be a false breakout?

While we think this market more resembles a 2013-type of rally environment rather than the chop of 2014-2016, we want to be on the lookout for potential cracks in the armor.  We offered up some stats in our last post that confirmed our bullish bias however we also know markets don't go straight up and even in strong years like 2013 there were plenty of small pullbacks and consolidations.

Below are some of the measures we're watching that may be a tell for a pause in the uptrend. 

• High Beta vs Low volatility ratio has peaked
• The current weakness in oil
• The pullback in high yield and junk bonds
• Small cap weakness
• Narrowing leadership
• Length of current move without correction

A longer term chart of the S&P 500 showing the breakout to the upside of a large wedge formation.  It this real or fake-out?  Only time will tell.

Every time the high beta vs. low volatility ratio peaked and then broke its uptrend the general market has also peaked and pulled back. 

Oil and Junk Bonds had a rough time last week while small caps have underperformed by a wide margin over the last month.

The % of stocks above their 50-day moving average continues to lag as the S&P has rallied.  This measure peaked in January and for the market to sustain its momentum, leadership will have to widen.    

We've now gone 90 days with out a 5% correction.  Getting long in the tooth? Perhaps but today's rally (post-Fed hike decision) in everything except the dollar could offer more fuel to the bull thesis over the near-term.  

Assessing the current market and a look ahead to March

March:

• The last 20 years the average March has been bullish with an average gain of 1.85% and typically trends higher all month.  It ranks as the 3rd best month of the year.

• Since 1950 March ranks as the 4th best month with an average gain of 1.25%.

• If we get a positive January and February (like we have in 2017), March returns are better with an average gain of 1.5%.

• The full year average gain is roughly 20% when January and February were positive.

• Also, the average drawdown in March is much less severe when January and February are positive.

 

The weekly blog from Fat Pitch had a number of stats about the current market.  The most interesting looked at the average yearly gain in the S&P 500 when January and February were both positive.  "The third long term study relates to seasonality. Specifically, with two days left in February, the SPX has risen almost 6% YTD. In the 27 prior instances since 1945 that SPX has been up in both January and February, it has closed up for the full year all 27 times. The average full year gain was 24%; in only 2 cases was full year gain less 10% (from CFRA)."

Below we ran our own study below that looked at every March period since 1950 when January and February were positive.  It then calculates the yearly gain for the full year when these conditions were present.  Our work confirms the CFRA numbers. 

The above data is consistently positive.  A few factors we track that could derail the market's current momentum would be: sentiment, breadth, VIX, and length of the current move.  Sentiment in and of itself shouldn't be used to identify tops but once you couple it with a bigger move and a deterioration in breadth it can help identify turning points.  Since 2009, there have been 19 "small-ish" corrections ranging from 4% to 9%.  The average number of trading days between one of these pullbacks lasted 46 days.  The current uptrend has lasted 77 days since the last pullback of at least 4%.

That could be a signal of things being a bit overdone and perhaps this move soon exhausts itself.  Out of the 19 streaks only 4 have lasted longer than the current market move with the longest lasting 140 days.  If we look at a simple breadth measure of number of 52-week new highs in the S&P 500 (Middle Chart in orange) we can see how breadth peaked in December.  Various other breadth measures also confirm the lack of participation as the general market continues to make new highs.
To add to this, the market remains overbought as the RSI shows in the bottom panel.

The 2nd chart below from Nautilus Research looks at the forward returns of the S&P over the last 20 years after being up for 5 weeks in a row while also reaching a multiyear high (this current streak is the 15th such instance).  The results back up the idea that we could be due for some weakness in the near-term,

Overall, the market continues to drive higher and climb the wall of worry.  The stats favor a bullish tone for the month of March and the rest of the year for that matter.  However, looking at the average drawdowns and with breadth starting to lag the current momentum, we wouldn't be surprised to see a small pullback along the way.  We remain bullish and contend that any pullback/correction will most likely be shallow and short.  Unless circumstances change dramatically, the overall market remains strong.

What To Expect In February...

With January now in the books and the S&P having advanced 40 points, we looked back at February's past to see what might be in store for stocks in the coming month:

February Stats

• Going back to 1950 February is the 4th worst month with average gain of just 0.04%
• However it is also the 4th least volatile month
• Over the last 20 years it ranks as 5th worst month with average loss of -0.18%
• Over the last 10 years it ranks middle of the pack as it's the 6th best month with average gain of 0.39%.  However it's also been the 3rd most volatile month
• Post-Election years lean bearish

Last 20 years average Daily Trend.  No real consistency as the month is choppy.  

Post-Election Years

• Average return is a loss of -1.84%
•  9 of 16 February's have been lower
• Average draw-down from January close is almost twice that of the average draw-up
• -2.99% average loss in instances where the incumbent party lost
• Average loss of -2.40% when a Republican has won

While the stats above lean in the bearish camp all hope is not lost.  If we look at the average February following a positive January the story gets more positive.

• Average return is a positive 0.65%
• 64% of February's have been positive when January was positive
• Average draw-up from the January close is 90bps greater than the average draw-down

Dow In Tightest Range Ever: A Case for Short-Term Weakness

Friday's close made it official that the last month has been the most narrow 21-day (a full trading month) range (1.42%) in the history of the Dow Jones Industrial Index .  In other words, things have really stalled out.

With this in mind, we went in search of other narrow periods to see how the index performed over the following weeks.  The results were actually different than what we anticipated.

Returns in the Dow are weaker in the short-term looking out 5, 10, and 20 trading days versus the whole sample.  We do believe in the "trend is your friend" mantra and the path of least resistance remains up.  However, the data below suggests that we could be in for some slight underperformance before we resume higher.

Heading into the inauguration it wouldn't surprise us to see a volatility event as the VIX has been asleep for some time and the kick-off of the Trump presidency might serve as the perfect catalyst.

The big question we have: Is the selling the inauguration too obvious of a play at this point?  Everyone seems to be talking up this strategy.

Below: All instances where the 21-day range of the Dow was less than or equal to 2.25%.  We filtered out clusters. 

Where Do We Stand?

Overview and Technical View:

The S&P has been consolidating since the December 13th high of 2,277 and has hung around the 2,270 level for several weeks now.

After the big surge off the November low (9.3%) and the presidential election the index has decided to take a breather.  This has allowed some excessive overbought readings (rsi, stochastics, mcclellan) to be worked off.  And as the market got extended during the post-election rally, momentum in the form of breadth exhausted itself which caused the slowdown in price movement.

Yet this week we've started to see a resumption of breadth and momentum in a number of readings.   On January 4th the number of stocks up 4% flashed the highest reading since November 11th.  Couple that with multiple 80%+ days on NYSE Advancing Volume Ratio and we see some credibility that the market may be poised for another leg higher.

We're not much for putting price targets on markets but looking at Fibonacci extensions from the two years of congestion that the S&P is emerging gives us a soft target of 2350 at the the 161.8 extension level. 

Index's and Sectors

• From an index and sector view the technical picture looks positive.  All 10 major S&P sectors reside above their 50-day moving average joining the four major domestic index's.  Globally 6 of 9 major non-US markets are above their respective 50 day moving average.  
• From a seasonality standpoint January has averaged a loss of -.03% over the last 20 years.  This would put it in 8th place versus all other months.  The average daily trend of the S&P 500 over the last 20 years shows the typical peak coming in the first week of January.
 

Sentiment  and Volatility

• AAII bullish sentiment at 46.2% was the highest reading since November 23rd.  This marks the 8th consecutive week above 40%.  
• The CNN Fear and Greed Index stands at 67 flashing a Greed Signal however it is down from an Extreme Green reading of 83 one month ago. 
• The VIX is at 11.10 and has started the first week of the year down 20%

Leadership:

Banks have been the leaders of this market and continue to be on solid footing.  The group as a whole remains extended while digesting gains from November.  A look at GS tells the story.

Infrastructure plays (steel, chemicals, materials) are right behind banks in leadership.  Some have pulled back and could be setting up for another run higher.

Yesterday brought some rotation into FANG and growth stocks that have lagged the current leadership but are slowly emerging as a few rallied above their 50 day moving averages on volume the last few days.   NFLX remains the leader in the FANG group as that is testing all-time highs.