S&P500 - Perfect Year Complete, Time For The Encore & Final Farewells By: Steve Deppe | October 31, 2017
The SPDR's S&P 500 Index Fund, ticker symbol SPY, closed the month of October at $257.15, a monthly gain of 2.36%. This is now the 12th consecutive monthly increase for SPY, marking the trailing 12 months a perfect year. Since inception, this is the first perfect year for SPY. In fact, based on my records back to 1950, this is the first perfect year for the S&P 500, with our without dividends, period. If, on 10/31/2016, I told you Donald Trump would win the election on November 8th 2016 and SPY would then increase 12 consecutive calendar months, you'd have told me I'm certifiably insane (and if you think otherwise then you might actually be certifiably insane). The price of the S&P 500 can and will trade beyond the limits of human imagination, the linearity associated with this perfect year has been remarkable.
So, what on earth can SPY possibly do for an encore? For starters, the primary trend is up or "bullish" across any and all time frames. Since the primary trend of today is the most likely primary trend of tomorrow, it doesn't take a rocket scientist to identify that the path of least resistance is to the upside. Momentum is real in the world of investing, and as we move into the favorable portion of the calendar year for the S&P 500 there's a cluster of historical evidence that suggests there's probably an impressive encore on deck. Price is king, and there's nothing but air left on the chart.
First, the S&P 500's trailing 12-month return (ROC12) through October's close is 21.12%. Identifying all calendar years where ROC12 through October's close is greater than 20% reveals an interesting historical edge over the forward 1, 3, and 6 months. Following 20% ROC12's through October's close, the S&P 500's forward 1-month return has been higher 11 of 12 samples for median returns of 2.64% (perhaps our winning streak will make it to lucky number 13). The indexes forward 3-month returns are higher 10 of 12 instances for median returns of 5.73%, and the forward 6-month's been higher 10 of 12 samples for median returns of 9.88%. Additionally, the risk/reward relationship over the forward 3 and 6 months is skewed favorably with 4 samples recording double digit returns over the forward 3 months while just 1 sample saw the S&P 500 decline by more than -1%. Over the forward 6-month period, 6 samples saw positive double digit returns (2 of which were more than 20%) while the two decliners were both down less than 3%. Historically, this type of momentum has preceded a lot of booming through trend persistence, and not a lot of busting through mean reversion.
Second, the S&P 500's average 3-, 6-, 9-, and 12-month trailing returns (ROCAVG) record at 11.60% through October's close. Identifying all calendar years where ROCAVG was greater than 10% through October's close continues to tell the historical story of momentum persistence (this is to be expected as many of the same Octobers fit both studies). That said, the S&P 500's forward 1-, 3-, and 6-month returns have been higher 10 of 11 samples with favorable risk/reward characteristics. Lastly, October closes with ROCAVG readings of more than 10% have never been "the top" for the index. The S&P 500 has traded up by at least 8.41% or more at some point over the forward calendar year, and also closed a calendar month higher by at least 6.13% at some point over the forward 12 months. Calling tops will always remain an exercise in futility, no matter how lucky someone's gotten in the past.
Third, the S&P 500's price-only return just recorded a 7-month winning streak. This marks just the 9th seven-month winning streak since 1970, excluding overlapping samples. Interestingly, in the prior 8 samples in which a 7-month winning streak occurred, the S&P 500's total return over the forward 6 months has never been negative. The index is a perfect 8-8 for median returns of 9.88%. Once again there are no "tops" in the data set, and there's only one -10% correction that's unfolded over the forward 12-month period following month number 7. This would seem to be in agreement with work by the likes of Ryan Detrick CMT and Jeff Hirsch, who've pointed out how strong "unfavorable" periods tend to precede strong "favorable" periods. Historically, when it didn't pay to "sell in May", it usually doesn't pay to sell in November either.
Fourth, SPY just put a cherry on top of its perfect year by finalizing the month of October as what I call a "gap & go" month. "Gap & go" months are simply defined as calendar months where both the open and low are greater than the prior month's close. When this occurs during uptrends (defined by SPY closing the "gap & go" calendar month above its 12-month simple moving average) SPY's forward 1-month returns have been higher 16 of 19 samples, and SPY's forward 12-month returns have been higher 17 of 18 samples for median gains of 16.80%. Amazingly, 50% of the time SPY hasn't closed a calendar month below October's monthly close at any point over the forward 12 months. Technically, there are no tops in the data set, although June of 2000 was definitely close.
When I put the pieces of the puzzle together, a see a picture of a strong, healthy, persistent "bull market". While none of my work shared in this post is consistently predictive, or a holy grail, it is derived from the broad behavior of market participants, which I tend to believe is somewhat predictable. The primary trend is up, and during uptrends investors tend to be handsomely rewarded for investing in the most traditional sense. Keep it simple, keep it straightforward. I'm striving to make as much hay as possible while recognizing that I have no idea when the inevitable storm comes to town. But since prudent risk management prepares your defense while your offense is on the field, long-term investors don't need to run inside while the sun's still shining. You simply need to make sure your defense is prepared and ready to go in the event the bulls turn it over. Something as simple as a "trigger and adjust" rebalancing rule derived from monthly moving averages can help provide contingency plans in the event everything I shared in this post is wrong, i.e. there was no encore but instead just final farewells. Josh Brown perhaps wrote it best:
"We should always invest as though the best is yet to come but the worst could be right around the corner."
Don't let the fear of striking out keep you from playing the game. Steve Deppe
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