Key Points
Þ This is the worst start to a year in history
Þ If we are not in a recession, the pain should be limited to a correction, not a bear market
Þ Historical data suggest positive returns from here, but with volatility
Through Thursday’s close, the S&P 500 closed more than two standard deviations below its 50-day moving average for eleven straight days. This is practically unheard of! To understand just how uncommon this streak is, Bespoke Investment Group examined all such prior instances in stock market history.
Since 1929, there have only been 22 prior streaks where the S&P 500 closed more than two standard deviations below its 50 day moving average for at least ten straight days. The following table summarizes each instance.
Here are the takeaways:
· The overall results were solidly positive, whether one looks at one week, one month, three month, or six month time frames after the period of turbulence.
· The average returns are not only greater than the average return for all periods since 1928, they are more consistent.
· Six months after the 22 prior occurrences, the S&P 500 averaged a gain of 8.8%, with a positive return 73% of the time.
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This correction has similarities to last August’s. The price decline has been swift and the market has been near multi-year highs. The research firm SentimenTrader notes that it is rare to see such a severe decline so soon after reaching a 3-year high. Historically, one of two outcomes followed such sell-offs: The market either tended to worsen if a recession was in sight or it rallied if recession was avoided.
Are we in a Recession?
I have looked at numerous predictive models over the past two weeks and each one gives a low probability of recession at present. Leading indicators are softening, but not spiraling downward. Credit conditions are tightening, but only for below-investment-grade issuers.
Manufacturing seems to be in recession at present, but the majority of U.S. economic production comes from Services. Currently, the Services sector is showing sustained growth. Historical evidence suggests that if annual average industrial production is down for an entire 12 month period, then weakness spreads to the broader economy. Although this has not happened yet, we are certainly watching it closely.
Oil’s Effect
The Energy and Basic Materials sectors of the U.S. economy have certainly been hurt by oil’s dramatic price decline. Yet as a consumption-led economy, U.S. growth should be helped by lower gas prices. This effect has yet to be fully felt and will likely sustain consumer spending in coming months.
Before the stock market can stabilize, oil prices need to do the same. Analysts are divergent on the path of oil’s price, estimating anywhere from $60 to $10 per barrel by year-end. Although there is a lack of clarity on the direction of oil, historical analysis suggests we have reached an historical extreme in maximum peak-to-trough declines.
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Message Confusion from the Federal Reserve
Since the Federal Reserve waffled on raising interest rates last September, message confusion has added to market instability. While December’s .25% hike eliminated the “when” of initial rate hikes, it did not eliminate the “how much” in terms of how many more rate hikes the Fed might enact this year. Since November 2015, the S&P 500 has dropped 10.9%. This drop resembles historical pull backs after initial Fed rate hikes.
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For market stability to return, we believe the Fed will need to communicate its intentions more clearly and definitively.
Conclusion
Presidential election years are notoriously turbulent in financial markets. Although this year’s extremely negative start is certainly concerning, historical evidence suggests that—absent a recession—markets should recover significantly over the next six months.
Sam Sweitzer, CFA
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Disclosures
This newsletter is a publication of Anson Capital. It should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change.
Information presented does not involve the rendering of personalized investment advice, but is limited to the dissemination of general information on products and services. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client's portfolio.
Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment or investment strategy (including the investments and/or investment strategies recommended by the adviser), will be equal to past performance levels.
Anson Capital is registered as an investment adviser with the SEC. The firm only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements.
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