With the first trading day of December behind us, we are now in the final stretch of 2016 with just twenty trading days left in the year. Those of you who have been regular readers of this Report know that there are several market tendencies, or historical biases, that we highlight throughout the year. In many cases these are observations that have been documented over time within one of our favorite trading resources, the Stock Trader's Almanac; and include items such as market seasonality, the "January Barometer," and performance patterns surrounding presidential elections. Additionally, they have compiled ample data to support the sentiment that September and October are among the worst performing months of the year, while the month of December offers some of the best return numbers. In fact, December has historically been the single best performing month for the S&P 500 Index SPX and the Russell 2000 RUT (based on data back to 1950 and 1979, respectively). Furthermore, it is the second best performing month for major market indices such as the Dow Jones Industrial Average DJIA (using data from 1950 - April, 2014), the Nasdaq Composite Index NASD (using data from 1971 - April, 2014), and the Russell 1000 RUI (using data from 1979 - April, 2014).
Beyond the strong average performance, there are a few other notable return patterns that have historically held true during the month of December. For instance, it is often believed that much of the returns for the month come in the latter half of the month. The Stock Trader's Almanac mentions strong end of month performance as part of its "Santa Claus Rally" study, stating, "Santa Claus tends to come to Wall Street nearly every year, bringing a short, sweet, and respectable rally within the last five days of the year and the first two in January." However, today we wanted to address the historical performance dispersion between the first half and the second half of December. We have gathered return data for the SPX and the DJIA for three different segments: the first half of the month, the second half of the month, and the month as a whole. The results are in the table below, and confirm that the entirety of the average net gains for both the SPX and DJIA come in the second half of the month. Taking this one step further, the underlying data shows that the SPX has a positive return in the first half of the month about 60% of the time, versus a 78% success ratio of positive returns in the second half of the month. The DJIA results are similar with only 57% of the years tested yielding gains in the first half of December, while the second half of the month saw gains approximately 71% of the time on average.
Another December theme that presents itself more often than not over the years is the outperformance of Small Cap stocks relative to Large Cap names. The Stock Trader's Almanac theorizes that this is attributed to the "January Effect" that over the years has moved earlier and earlier within the calendar year. The overall concept is that many beaten down small stocks being dumped for tax loss purposes begin to rebound in December and this effect continues to spill over into January as investors are willing to accept more risk in the portfolio. The chart below looks at the average excess return of the S&P 600 Small Cap Index SML over the SPX for each month of the year. Notice that December has, in fact, on average, provided the greatest margin of outperformance by Small Caps going back over the last 27 years.
When we think about these December biases in context with the current market, December 2016 very well could be setting itself up nicely to follow in the footsteps of the Decembers before it. The US equity indices remain in overbought territory after a record November, which carried us to new all-time highs. A continued pullback to more reasonable levels, caused by near term selling pressure in the first half of the month would certainly not come as a surprise. Additionally, with respect to the Small Cap story, we have seen notable improvement both on an absolute and relative basis across that segment of the market. The SML completed a new RS buy signal versus the SPX just over a week ago, and the "All US Small Cap" group has moved to the top of the Group Score leader board with an average score of 4.29. We will continue to monitor the markets for any material changes between supply and demand, but a strong finish to the year with Small Caps leading the charge is something our indicators currently support.
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DISCLAIMER This article was prepared by Dorsey, Wright & Associates, LLC, a Nasdaq Company. Dorsey Wright is a registered investment advisory firm. The returns above are based on the performance of the applicable index. Investors cannot invest directly in an index. Indexes have no fees. Past performance is no guarantee of future results. Potential for profits is accompanied by possibility of loss.
The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. Relative Strength is a measure of price momentum based on historical price activity. Relative Strength is not predictive and there is no assurance that forecasts based on relative strength can be relied upon.
Neither the information nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities, commodities or exchange traded products. The information contained herein has been prepared without regard to any particular investor’s investment objectives, financial situation, and needs. Accordingly, investors should not act on any recommendation (express or implied) or information in this material without obtaining specific advice from their financial advisors and should not rely on information herein as the primary basis for their investment decisions. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.
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