Small Caps On Sale: Seasonal Bounce Ahead? There has been a good deal of rhetoric lately as to how small caps have underperformed badly recently. On closer examination however small caps have actually performed right in line with historical seasonal patterns (yes, the magnitude of the moves have been greater) and they appear poised for their usual seasonal breakout which tends to begin in late-November, but does not fully get underway until mid-December. The chart below taken from page 110 of the Stock Trader’s Almanac 2018 shows the one-year seasonal pattern of the ratio of the Russell 2000 to the Russell 1000 from July through June to highlight the perennial low point of this relationship, November and the winter rally mentioned above. We have added the performance of this ratio in 2018 so far through today’s close and updated the historical average pattern through June 30, 2018. While this year’s pattern has more amplitude, the trend is quite similar to the historical pattern. Small caps underperformed from late June through mid-August, then had the usual pre Labor Day rally, followed by a customarily weak October. It now appears that small caps could be setting up nicely for their season of outperformance.
Thanksgiving Market Returns Nov 16, 2018 Thanksgiving week has historically been a positive time for the equity market. Since WWII, the S&P 500 has averaged a gain of 0.64% during Thanksgiving week with gains three-quarters of the time. Market trends heading into this Thanksgiving aren’t as positive for the bulls, though. As shown in the table below, during years where the S&P 500 was positive but up less than 5% YTD heading into Thanksgiving week, the index’s average change during the week has been 0.00% with gains less than half of the time. On a day to day basis, for both all years since WWII and in years where the S&P 500 was up less than 5% heading into Thanksgiving week, Monday has been the worst trading day as it is the only day of the week with negative average returns and positive returns less than half of the time. Tuesdays and Friday, however, have been positive days, though, with average gains of 0.10% and 0.29%, respectively. Additionally, for those years where the S&P 500 was up YTD but up less than 5%, Tuesdays and Fridays have been even stronger with average gains of 0.26% and 0.35%, respectively. As we move past Thanksgiving, though, seasonal trends for the market based on this year’s performance so far improve. In those years where the S&P 500 was up less than 5% YTD heading into Thanksgiving week, the average gains the week after Thanksgiving was 0.41% with positive returns 55% of the time. For the remainder of the year, average returns were even stronger at +2.83%. Not bad for a period of just over five weeks!
Trading Thanksgiving: Long Into Weakness, Exit into Strength by Week’s End Trading around Thanksgiving has a bullish tendency perhaps buoyed by the “holiday spirit.” First published in the 1987 Stock Trader’s Almanac, the Wednesday before and the Friday after Thanksgiving combined were up 34 times in 35 years. The only S&P 500 decline was in 1964. Subsequently, this trend changed. In the 31 years since 1987, there have been 8 declines and 22 advances. The best short-term trade appears to be getting long into weakness on Monday or Tuesday of Thanksgiving week and selling into any subsequent rally by the end of Thanksgiving week, but remain nimble as events like Greece’s debt crisis in 2011 can cancel Thanksgiving on Wall Street. Also of note is the change in the yearend rally. Prior to 1987, from the close of trading on the Friday after Thanksgiving to yearend, the S&P 500 rallied only 20 times in 35 years. As Thanksgiving bullishness lost steam in 1987, the rally afterwards occurred more frequently. Since 1987, S&P 500 has logged gains in 24 of 31 years from the close on Friday after Thanksgiving to yearend.
Reagan’s Split Congress Produced 12.9% Average Annual DJIA Return Of the six combinations of political alignment possible for the White House, the House of Representatives and the Senate, the best combination for DJIA from 1949 through the end of 2017 has been a Democrat in the White House and Congress controlled by the Republic Party with average annual gains of 16.1%. Second best was a Republican in the White House with a Republican Congress at 15.6%. Both of these results compare favorably with the average performance in all years of 8.6%. Over the same time period, the worst combination for DJIA performance was a Republican President and full Democratic control of Congress with an annual average gain of just 4.9%. Under a Republican President and a split Congress, DJIA has averaged gains of 6.7%. This is neither the best nor the worst historically. Last time we had a Republican President with a Split Congress consisting of a Democratic House and a Republican Senate was during Ronald “The Great Communicator” Reagan’s first six years in office. To start off his term the market topped on April 27, 1981 for DJIA (11/28/1980 for S&P and 5/29/1981 for NASDAQ), which culminated in the bear market bottom on August 12, 1982 (Aug 13 for NAS). However, these were some of the most productive years for the federal government as The Great Communicator had a worthy adversary, or partner really, in veteran statesman and sitting Speaker of the House, Tip O’Neill. Reagan and O’Neill worked diligently together compromising and passing legislation and instituting policy that would shape and fuel the information revolution and the last secular bull market and Super Boom. In those six years from 1981 to 1986 DJIA averaged 12.9% annually. Similarly, when Bill Clinton lost Congress in his first midterm election in 1994, the market and economy resumed the Boom in 1995 as new Republican Speaker Newt Gingrich and Clinton worked together despite their many differences of opinion and ideology. There is hope for the next two years if the Democratic Speaker and President Trump decide to put the country ahead of politics and rhetoric.
LEI-ding the Way to No Recession The Conference Board’s Leading Economic Index (LEI) is one of our favorite economic indicators. It is designed to predict future movements in the economy based on a composite of 10 economic indicators (like manufacturers’ new orders, stock prices, and weekly unemployment claims) whose changes tend to precede shifts in the overall economy. Last week, the LEI painted a continued strong backdrop for future economic growth, as it rose slightly above the previous month and 5.9% year over year (YoY). Looking under the hood, the LEI has risen or been flat for 29 consecutive months, the longest streak in more than 30 years. While the yield curve, peak earnings, Federal Reserve (Fed) worries, and trade issues with China have been getting all the attention recently, all recessions going back to the early 1970s first saw the LEI turn negative YoY; and because of its solid track record of predicting recessions, the LEI is a component of LPL Research’s Five Forecasters. As our LPL Chart of the Day shows, the LEI is nowhere near turning negative. “The fact that the LEI has been very successful at forecasting recessions, and is one of the few forward-looking economic indicators, make it one of our favorites. The continued strong data suggest a recession is nowhere in sight and signal solid underlying fundamentals in the U.S. economy,” said Ryan Detrick, LPL senior market strategist. Last, examining all seven recessions going back to early 1970 shows some interesting developments. It turns out the LEI turned negative year over year on average eight months (with a median of six months) before a recession officially occurred. That is what we call a nice track record. Again, with the LEI up 5.8% year over year, we believe we are a long way from this economic indicator flashing any major recession warning.
Nasty Thanksgiving Week Does Not Signal Market Demise Hold on a second. Yes, this was the worst Thanksgiving week for the S&P 500 since 2011 and the 5th worst since 1930. But this does not mean the bull market is over for stocks and there is no upside. Just look at the table below of the S&P 500’s performance following all down Thanksgiving weeks since 1930. Sure the market was horrible back in the 1930s at the depth of the Depression, but 1933 was up 46.6% following down T-Week in 1932. 2011 was a great entry point and the following year 2012 was solid up 13.4%. More down T-week years ended in the black and 71.4% had solid gains to finish the year. So don’t let the market’s turkey hangover get you down.
All Aboard the Santa Claus Rally Bandwagon This never gets old and it’s a testament to the brilliance and iconic thinking of Yale Hirsch, my illustrious father and founder of the Stock Trader’s Almanac. Everyone on Wall Street is either officially on the Santa Claus Rally bandwagon or vehemently against it. Either way, as soon as Thanksgiving comes around on the calendar – or even Halloween – all the talk on The Street is: “Will we or won’t we have a Santa Claus Rally?” But they all refer to it as the 4th Quarter Rally or the November-December Rally or the December Rally or the Halloween-New Year’s Rally or the Thanksgiving-Christmas Rally. But they have it all wrong. Yes, the market has a strong tendency to rally smartly in Q4, but that is not the Santa Claus Rally. The Santa Claus Rally was discovered and named by Yale Hirsch in 1972 and published in our 1973 Stock Trader’s Almanac. As defined by Yale and detailed on page 114 of the newly released 52nd Annual 2019 Edition: “Santa Claus tends to come to Wall Street nearly every year, bringing a short, sweet, respectable rally within the last five days of the year and the first two in January. This has been good for an average 1.3% gain since 1969 (1.3% since 1950 as well). Santa’s failure to show tends to precede bear markets, or times stocks could be purchased later in the year at much lower prices. We discovered this phenomenon in 1972.” To Wit, Yale’s witty rhyme which has become the headline of our “Santa Claus Rally” page and the battle cry of market pundits during the holiday season: If Santa Claus Should Fail To Call, Bears May Come To Broad And Wall At least Wikipedia and Investopedia have it right. For what it’s worth here are the results of the Santa Claus Rally and the full year since 1994. Every single year Santa failed to call the market either suffered a bear market or a flat year. Check the Almanac for the full history or do your own research. It’s not a perfect record, but as Yale wrote in 1972, the “record of daily percentage changes during the holiday season may not make interesting reading. However, we have examined it with a microscope and have found something of predictive value.” It’s still working… I am thankful for Yale and the Almanac.He just turned 95 and lives nearby with mother.
December Almanac: Top Performing S&P 500 Month December is the number one S&P 500 month and the second best month on the Dow Jones Industrials since 1950, averaging gains of 1.6% and 1.7% respectively. It’s also the top Russell 2000 (1979) month and second best for NASDAQ (1971) and Russell 1000. Rarely does the market fall precipitously in December. When it does it is usually a turning point in the market—near a top or bottom. If the market has experienced fantastic gains leading up to December, stocks can pullback. Trading in December is holiday inspired and fueled by a buying bias throughout the month. However, the first part of the month tends to be weaker as tax-loss selling and yearend portfolio restructuring begins. Regardless, December is laden with market seasonality and important events. Small caps tend to start to outperform larger caps near the middle of the month (early January Effect) and our “Free Lunch” strategy is served from the offerings of stocks making new 52-week lows on Triple-Witching Friday. An Almanac Investor Alert will be sent prior to the open on December 24 containing “Free Lunch” stock selections. The “Santa Claus Rally” begins on the open on Christmas Eve day and lasts until the second trading day of 2019. Average S&P 500 gains over this seven trading-day range since 1969 are a respectable 1.3%. This is the first indicator for the market in the New Year. Years when the Santa Claus Rally (SCR) has failed to materialize are often flat or down. The last six times SCR (the last five trading days of the year and the first two trading days of the New Year) has not occurred were followed by three flat years (1994, 2004 and 2015) and two nasty bear markets (2000 and 2008) and a mild bear that ended in February 2016. As Yale Hirsch’s now famous line states, “If Santa Claus should fail to call, bears may come to Broad and Wall.” In the last seventeen midterm years, December’s rankings slip modestly to #3 S&P 500 (1.8%) and DJIA (1.5%) and #5 NASDAQ (0.6% since 1974). Small caps, measured by the Russell 2000, also perform well in midterm Decembers. Since 1982, the Russell 2000 has lost ground just twice in nine midterm years in December. The average small cap gain in all nine years is 0.7%. In 2010, Russell 2000 gained 7.8% in December.
ISM Manufacturing Rebounds Dec 3, 2018 Today’s release of the ISM Manufacturing report for November broke a string of back to back declines in the index and easily surpassed expectations. While economists were forecasting the headline index to come in at a level of 57.5, the actual reading came in at 59.3. Breadth in this month’s report was pretty much split right down the middle as five categories showed increases, four declined, and one was unchanged. On a y/y basis, it was less positive. Although the headline index is higher than it was at this time last year, seven out of ten components are down. The biggest decliner on a m/m and y/y basis was Prices Paid. In November, Prices Paid declined from 71.6 down to 60.7, which was the largest m/m decline since June 2012. For those worried about rising inflation, this month’s decline provides some comfort. Finally, with the November jobs report coming up Friday, we wanted to note that the employment component of this month’s report increased from 56.8 up to 58.4, indicating another healthy jobs reading for the manufacturing sector at least. We’ll be paying closer attention, however, to the ISM Services report which will be released on Thursday morning. The Services sector makes up roughly 80% of the US economy compared to just 20% for the manufacturing sector.
Typical December Trading: Strength Early and Late, Choppy Between Historically, the second trading day of December, today, has been a modestly bullish day with S&P 500 advancing 36 times over the last 68 years (since 1950) with an average gain of 0.13%. To find a worse second trading day of December, you would have to go all the way back to 1932 when S&P 500 dropped 3.86%. Trade remains a concern, but today’s sell off appears to have been triggered by economic growth fears caused by a flattening Treasury yield curve and 5-year yields dipping below 2-year yields. As we have repeatedly noted, the Fed is the biggest risk to the market and the economy. These fears could lead to a larger than usual amount of choppy trading during the first half of December. Historically December has opened with strength and gains over its first five trading days before beginning to drift. By mid-month all five indices have surrendered any early-month gains, but shortly thereafter Santa usually visits sending the market higher until the last day of the month and the year.
Looking at the Yield Curve From everyone at LPL Research, we first want to offer our thoughts to former President George H.W. Bush’s family. Most of his life was lived in service to the United States, and he will be greatly missed. Turning to markets, the spread between both 3- and 5-year and 2- and 5-year Treasury yields turned negative earlier this week for the first time since July 2007. This indicates that the short end of the yield curve has inverted, which has many wondering if a recession will soon follow. Some of yesterday’s equity market drop was also attributed to continuing flattening yield curves. To clarify, a yield curve is a graphical representation of the yields of bonds with similar credit quality across a range of maturities. A flattening curve, when shorter-term rates rise more quickly than longer-term rates (or fall more slowly), is often perceived as an indication that slower economic growth lies ahead. An inverted yield curve, where short-term rates are higher than long-term rates, has historically been a precursor to a recession. However, in terms of their predictive power, not all spreads are equal. Inversions at the short end of the yield curve, like we’re seeing now, have had very little consistent predictive power for future recessions. The longer end of the yield curve has historically had the best predictive power. In fact, according to data from the San Francisco Federal Reserve Bank, the 1-year and 10-year Treasury yield spread inverted prior to all nine recessions going back 60 years. Another more common measure of yield curve steepness, the 2- and 10-year Treasury yield spread, dropped to 0.11% this week—its lowest level since July 2007. Here’s the catch: The yield curve isn’t inverted, and we’ve seen periods with a relatively flat yield curve that have lasted for years before a recession (the mid-to-late 1990s, for instance). With strong corporate profits, high confidence levels, a more accommodative Federal Reserve, and the benefits from fiscal policy still being felt, we do not anticipate a recession over the next 12–18 months. But what happens if the more predictive yield curve finally invert? As our LPL Chart of the Day shows, equities can continue moving higher even after the yield curve inverts. LPL Research Senior Market Strategist Ryan Detrick explains: “Contrary to what many people think, inverted yield curves don’t always sound the alarm to sell. In fact, looking at the past five recessions, the S&P 500 didn’t peak for more than 19 months, on average, after the yield curve inverted, along the way adding more than 22% on average at the peak.”
Services Sector Continues to Hum Along Dec 6, 2018 The ISM Non-Manufacturing report for the month of November showed that the services sector of the economy (the lion’s share) continues to hum along. While economists were expecting the headline index to come in at a level of 59.0, the actual reading stayed above 60, hitting a level of 60.7. What’s notable about this is that even though it is still off its highs from two months ago, the current string of back to back to back readings above 60 is the longest streak of 60+ readings since the survey began in 1997! On a combined basis and accounting for each sector’s share in the overall economy, the combined ISM for the month of November was 60.6, which is also among the highest readings on record. Breadth in this month’s report was somewhat mixed. Of the index’s ten sub-components, six were up in November and four were down, but all of them are still well above 50 – the threshold for growth. The key gainer on the month was Business Activity (top chart below table), which is back at its highest levels of the cycle, while one of the bigger disappointments to the downside was Employment, which has seen a bit of a reversal from its recent surge higher in the prior few months (lower chart).
US Stock Market Performance During Years Ending In… Dec 10, 2018 Below is a quick market stat to log as 2018 nears an end and 2019 approaches. In the chart, we show the S&P 500’s average price change in years ending in 0 through 9. This data goes back to 1928 when the S&P 500 begins. As shown, years ending in “8” have historically seen the S&P 500 gain an average of 10.7%. At one point earlier in 2018, this type of gain seemed likely, but not anymore now that the S&P is down 2% YTD. Years ending in “9” have historically seen an average gain of 8.1%, which is just a hair above the average of 7.5% seen for all years since 1928. The best years have come in years ending in “5” with an average gain of 22.4%. Years ending in “3” rank second with a gain of 15.4%. On the negative side, years ending in “0” and “1” have both averaged losses throughout history. Below we show the consistency of positive returns for the S&P 500 in years ending in “0” through “9”. As shown, years ending in “5” have been positive 88.9% of the time (8 out of 9), while years ending in “0” and “1” have been positive just 44.4% of the time (4 out of 9).
The Intraday Correction Dec 10, 2018 A key characteristic of this correction during its early stages in late September and October was the unrelenting selling pressure that went on during regular trading hours. While futures were either flat or even pointed higher on a lot of trading days, the selling began pretty much immediately after markets opened at 9:30 AM ET and didn’t let up until the 4 PM close. This type of intraday selling is not a bullish sign, so today we wanted to update the readings to see where things stand as the correction closes in on three months in length. Below we show the cumulative change since 9/20 (the date of the high for the S&P) of buying SPY at the close every day and selling at the next open (after hours) versus buying at the open every day and selling at the close (intraday). If you only owned SPY after hours during the current correction, you’d actually be in the green with a gain of 1.1%. Had you only owned intraday by buying at the open and selling at the close, however, you’d be deep in the red with an 11.2% decline. This means that more than 100% of the S&P’s losses during the current correction have come during regular trading hours. Looking at this strategy for all of 2018, had you only owned SPY after hours this year, you’d still be up 10.8%. If you only owned during regular trading hours, you’d be down 10.9%. As you can see in the chart, there were two periods where these two strategies diverged. One came towards the end of Q1 into early Q2 when the after-hours strategy traded sharply higher as the intraday strategy plummeted. The second came at the start of the current correction when the intraday strategy started to collapse while the after-hours strategy continued to tick higher.
Stocks Tend to Ignore Shutdowns Next week could bring the third government shutdown of 2018, especially after the fireworks out of Washington yesterday. In a widely watched live TV debate, President Trump sparred with Senate Minority Leader Schumer and House Minority Leader Pelosi regarding funding for the proposed wall on the Mexican border and potentially shutting down the government. What exactly does a shutdown mean for stocks? “Although shutdowns get a lot of media hype, the reality is that stocks tend to take them in stride. In fact, the S&P 500 has gained during each of the five previous shutdowns,” explained LPL Senior Market Strategist Ryan Detrick. As our LPL Chart of the Day shows, shutdowns rarely push stocks significantly lower and have corresponded with a flat median return in the previous 20 shutdowns going back more than 40 years. One would think shutdowns in December might be rare, but they’re actually fairly common. Three shutdowns in the same year, however, is not. Could this year be the first since 1977 with three separate shutdowns? If yesterday’s drama was any indication, the odds may have increased. However, next summer’s debt ceiling debate will be a more important issue when Treasury interest payments are at risk.
Is It Time For Santa? So far it’s been rough for stocks in December, a month that has historically been bullish. How bad has it been? After 10 trading days, we’re off to the worst start to December since 1980! In fact, the S&P 500 Index is flirting with “worst month of 2018” status, currently held by October (-6.9%). Since 1957, when the S&P 500 started in its current form of roughly 500 stocks, December has never been the worst month of the year. Is there still time for a Santa Claus rally? “December has been a month to forget for equities so far, but there is a silver lining. Turns out, the majority of December’s gains tend to happen the second half of the month—so we still have time to believe in Santa,” explained LPL Senior Market Strategist Ryan Detrick. As our LPL Chart of the Day shows, December is historically a strong month that has tended to see the majority of its gains late in the month. What could spark a Santa rally? It very well could be today’s Federal Reserve Bank (Fed) decision on interest rates.
Putting an Extremely Volatile Market in Perspective On Monday, the S&P 500 Index came about as close as possible to the technical definition of a bear market without officially registering one (defined as a 20% or larger decline based on closing prices). Enduring these sharp declines can be unnerving for any investor, making it difficult to avoid the urge to react and sell at market lows. To hopefully provide some reassurance and perspective, we offer some historical context about this recent volatility and the relationship between bear markets and recessions. Going back to World War II, there have been 14 bear markets, with 7 of them accompanied by a U.S. economic recession and 7 during economic expansions. The recessionary bear markets were quite painful for stock investors, with an average S&P 500 decline of 37%. Bear Markets Occurring Without a Recession A look at the non-recessionary bears is a bit more comforting. Three of the past four non-recessionary bears ended at 19% corrections. The fourth, a 34% decline in 1987, occurred under very different conditions. The S&P 500 was up more than 40% year to date in August 1987, compared with gains just below 10% through the September 20 high this year, while long-term interest rates shot up from 6% to 9% in 1987. Including 1987 and the four other non-recessionary bears before then (1947, 1962, 1966, and 1978), the average non-recessionary bear market drop is 24%. Bottom line: U.S. stocks have endured swifter, shallower bear markets when the economy isn’t in a recession. When the U.S. economy is growing as it is now, and as we expect it in 2019*, those declines have tended to stop at around 20%. What Does That Mean for Today? Most relevant to our investment decisions today, it is important to consider that stocks have historically recovered quite a bit faster from non-recessionary bear markets than from those that are accompanied by a recession, as shown in the LPL Chart of the Day. According to LPL Chief Investment Strategist John Lynch, “In bear markets accompanied by recessions, the S&P 500 has taken an average of about 34 months to recover its prior peak. In bear markets without recessions, the S&P 500’s time to recover its prior peak is shortened to only about 11 months. In the last two bear markets without recessions, the S&P 500 recovered in 3 months (1998) and 5 months (2011).” We understand that in this volatile market environment, it can be difficult to stick to your long-term investment plan. We hope this historical perspective helps in that regard. Over the long term, stocks have proven to be quite resilient as the economy expands and companies adapt, innovate, and drive profit growth over time. We encourage investors to remain focused on the many fundamentals supporting growth in the economy and corporate profits, and stick with your investing strategy.
