Long-term secular trends reasserted themselves during October. Major global equity markets have rallied from their summer swoons. For example (returns through market close on 10/29/15):
|Price Change Month to Date||Price Change Year to Date||Price Change Trailing 12 Mos.|
|S&P 500 Index||+8.8%||+1.5%||+5.4%|
|Russell 2000 Index||+5.9%||+0.1%||+1.7%|
|EAFE Index (Foreign Developed)||+8.0%||+0.1%||-1.6%|
|EEM (iShares Emerg. Market ETF)||+6.2%||-11.4%||-16.3%|
|REIT Index (VNQ)||+6.9%||-0.5%||+4.0%|
|10-Year U.S. Treasury (Yield Change)||+0.13%||+0.02%||-0.15%|
Data Provided by Thomson Reuters
The market rebound has been broad and strong. While the S&P 500 index was up 8.8 percent last month, the German DAX index is up a whopping 11.8 percent and Japan’s Nikkei 225 Index is up 8.9 percent. The rally has bled into the longer suffering emerging markets; the EEM (iShares Emerging Market ETF) was up 6.2 percent last month.
Will the recent strength in stock prices persist going forward? Am I calling an all clear at this stage? Let’s dig a little deeper into trading action within the U.S. markets for a hint as to the near-term possible direction of stock prices.
Fundamental Factors Driving Stock Prices
What changed over the last month to reverse the trend of stocks prices? The fundamental drivers of this reversal have been:
Oversold Conditions. From May 21 – Aug. 17, 2015, the market declined by 1.3 percent in volatile trading action. The serious decline started Aug. 20, 2015, when the S&P 500 declined by 2.9 percent in one day, closing at 2035. This is the day China’s officials cut the value of their currency. The market continued to selloff until August 25 when the S&P 500 closed at 1867, down 11.2 percent over a mere six days. This type of downward move can be considered a selling climax, a period when the market may have entered an oversold state.
Earnings Season. We are in the middle of Q3 earnings reports. So far, 77 percent of the S&P 500 companies which have reported have beaten estimates. Typically, the “beat” rate is around 70 percent. Earnings season is going better than expected, adding upside pricing to companies which are beating estimates.
Recently Mario Draghi, president of the European Central Bank (ECB), dropped hints that at the Central Bank’s next scheduled meeting it may expand its bond purchase program. This program is currently running at around $67 billion of purchases per month – similar to the Fed’s third round of QE actions that took place from September 2012 through October 2014. European markets in particular rallied strongly on these hints.
China Lowered Interest Rates. China lowered their official interest rate to 4.35 percent, a reduction of 0.25 percent from previous levels. Recently, China announced their Q3 GDP growth rate of 6.9 percent which is a little lower than target desired growth rates. Share prices rallied in response to this interest rate cut.
Market Seasonality Is Now Our Friend
Those who have read my work over the years know I rely on historical trading patterns, valuation comparisons and other variables when considering overall capital market conditions. One of the more reliable oddities of market returns has been the Sell in May and Go Away concept. This concept states that stock prices, on average, tend not to change significantly between May and October. According to the folks at Stock Trader’s Almanac, from 1950 to 2014:
- The average price change of the Dow Jones Industrial Average from May 1 - October 31 has been 0.3 percent per year. Even after the recent stock market rally, the Dow is down 0.95 percent since the close on April 30, 2015. So the Sell In May concept has held up again this year.
- The theory also shows the period of November 1 - April 30 (Buy In the Fall and Have a Ball) has shown a historical average return of 7.6 percent, representing more than 96 percent of the returns available (on average) during the entire year period. Last year, from October 2014 - April 30, 2015, the Dow was up 2.6 percent.
Beneath the Surface, Trader’s Actions are Telling a Different Story
Certain market actions in the second half of October raised eyebrows and concerns in some circles. The options market is awash in fear, according to my friends at Barron’s magazine. Trading action in the S&P 500 and the CBOE Volatility Indexes is suggesting worries are rampant that the stock market may decline sharply by January.
For example, the price of one S&P 500 “put” option (a bet the market will decline) is at a multiple of a similar “call” option (a bet the market will increase). The ratio of put-to-call pricing has recently reached 22-to-1. Additionally, the VIX index (some call this index a fear gauge) seems, on the surface, to be reasonably calm. When you look beneath the surface, though, there is a different story. A number of short-term traders are whispering that the equity market is vulnerable to another downward push.
On the other hand, from a technical standpoint, global equity markets are on the cusp of moving above their 200-day moving averages, a sign which normally brings additional capital to the markets. The S&P 500 has penetrated its 200-day moving averages, and the major European markets are on the verge of doing the same.
My Bottom Line – Embrace the Fear – Stay Bullish
I have consistently been advising clients to remain bullish in this environment, and to remain calm during this downturn. Look over the longer term, as my view holds that the world is experiencing its fifth secular bull market since 1900.
The previous four secular bull markets lasted an average of 14 years prior to exhaustion. If my reckoning is correct, the current secular bull started in 2009 and just celebrated its sixth year anniversary.
While the market may swoon 10 - 20 percent in value -- if this bull market is to be similar to previous bull episodes -- we have a ways to run to the upside.
Bill Greiner is Chief Investment Strategist at Mariner Holdings.