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Does The Rally Have Legs? - Analyst Blog

Posted
8/5/2013 2:40:00 PM
By: Zacks.com
Referenced Stocks:DIA;IWM;QQQ;SPY

On the weekends, I like to go on long bike rides or runs.  Although refreshing, the events can become monotonous and my mind can wander toward market related topics.  During this weekend's excursion, the following questions came to mind:  1) Is this year's stock market return unusual? 2) Can the rally continue into year end?   Let's put this year's rally into perspective and see what history says about performance into year end.  

The backdrop:

The S&P 500 was up 18%, excluding dividends, through the end of July. The gain seems strong on the surface and may be a factor which makes investors either cautious or excited about putting fresh money to work in August.   18% would be a solid yearly return and we are just in early August.  

It was recently reported that stock investors poured $40 bln into the equity market in July, so investors are starting to warm toward owning stocks.  The 4-week average of the spread between the American Association of Individual Investors Bull and Bear indices was 22.5 last week and on the elevated side of recent history.  Despite these signs of investor interest, there is a lot of fire power in bond funds and money market/savings accounts which could rotate into the equity market.  

Looking at yearly returns:

Going back to 1928, the S&P 500 has posted an average yearly return of 7.22%.  The worst return occurred in 1931 when the index sank 47.07%, while the best return occurred in 1954 when the index surged 45.02%.

The S&P 500 was able to post a gain over 18.0% 27 years of 85 years or 32% of the time.   It is interesting and maybe somewhat surprising that the index has been able to post a gain above 18% almost 1/3 rd of the time since 1928. 

The chart displays an Excel generated histogram of yearly return.  It appears that the majority of returns are clumped between -12.50% and +27.50%.  Using the distribution, 78% of returns fell in this range.

July to December returns:

There is slightly less than five months left in 2013. As a result, it is probably more important to look at returns between the end of July and end of December as a measure of the market's upside potential this year.  

The S&P 500 has a history of struggling between the end of July and the end of December.  Going back to 1928, the average return is -3.15%.  The return has been above 0% 29 of 85 years or just 34% of the time.  Thus, the S&P 500 has been down almost 2/3 rd of the time.

The largest gain was 34.66% in 1931, while the biggest loss was 32.45% in 1932.  The Great Depression seemed to generate volatility in return.  The graphic displays July to December returns by year.

It is noteworthy that stocks have been down four of the past five years in the July to December period. The exception was 2009 when the S&P 500 rose just 1.23%.  Bulls and bears may debate what this means for 2013.  The market may be due for a positive return given the track record of weakness in very recent years - mean reversion.  However, the pattern may embolden bears.   The market did rise 15.88% in the August to December period of 2007 - a period prior to the Great Recession and bull market for stocks.

Conclusions:

Answer to question 1 : History suggests that the rally in 2013 is not as dramatic as it may seem.   18% is strong, but is not that unusual from a historical basis.  By itself it does not argue against further gains. There seems to be room for further appreciation.  

Answer to question 2 : The market does not have a great track record of strong performance in the July to December period.  This result offsets the bullish vibe from question 1 and argues against a big finish to 2013.  

In my view, the data fits into an idea that the market will perform well in August, but September to October may be rough before prices finish the year on an upswing.   With the U.S. and Eurozone economies showing signs of firming given PMI data, events in Washington may be the determining factors for price action this fall.

Congress returns from recess on September 6 th and must address budget issues, the debt ceiling, for example.  The Fed will also be in play with QE taper debated.  Chairman Bernanke's leadership is coming to an end and the current QE program is flirting with its birthday.   Continued QE could keep the market bubbling higher. The correlation between the Fed's balance sheet size (level of reserve bank credit) and the S&P 500 remains strongly correlated. QE is an unusual event in history and may color drawing conclusions from history.



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