We’re on the Road to Nowhere

The headlines from a year ago, as usual, covered a wide range of events.  For example, Hillary Clinton announced her candidacy for the 2016 Democratic presidential nomination just before the governor of Maryland declared a state of emergency in Baltimore as riots began over the death of Freddie Gray.
Lighter headlines from a year ago included the birth of the Princess of Cambridge, Charlotte Elizabeth Diana who is 4th in line to succeed Queen Elizabeth II.  Also American Pharoah became the 12th winner of horse racing’s Triple Crown and the first since Jimmy Carter was president (1978).
This time last year in the financial markets, the U.S. stock market reached record levels.  This wasn’t noteworthy as stocks had been steadily moving higher for several years.  The Dow Jones Industrial Average closed at 18,312 on May 12, 2015 which turned out to be the last time the Dow has closed at a record.  This 377 day (as measure by calendar days, trading days plus weekends and holidays) streak without making a new high is the 12th longest stretch in history.
The longest time between record Dow closes was the
period from September 1929 to November 1952 which exceeded 9,200 days.  Certainly this is a unique time in history as it contains both an economic depression and world war.  Looking at what might considered a “normal” number of new highs in a year, there were 10 in 2015, 53 in 2014, and 45 in 2013.  The record is 77 in 1995.[i]
This twelve month Dow drought of record highs is part of a wider and multi-year trading range.  The S&P 500 first exceeded the 2,000 level in August 2014.  Since then and for the past 22 months the index has bounced between 1,850 and 2,130.  This is only the 5th time that the S&P has traded in less than 20% range over a 22-month period.  The last two incidents were in 2005 and 2006 which signaled the end of the bull market.  The other two occurrences were in 1984 and the mid-1990’s.  Both of these examples were resolved with the stock market moving materially higher.[i]
We would offer that many are not aware that the markets have been treading water for the past 2 years.  It’s a function of the narrow stock market leadership in 2015 (see FANG stocks) which gave the illusion of healthy landscape.  These handful of large companies drove the major averages while the rest of the market floundered.  Within the MSCI All-Country World Index (a wide scoping global stock index), 66% of the stocks in the index are lower than they were on May 21 last year.  Removing the emerging market portion (which were challenged in 2015) from this index, we still end up with 40% of the market lower than last May.[ii]  This market churn is clearly evident when we look at the year-to-date numbers for the U.S indexes:
Dow Jones Industrial Average           +2.6%
S&P 500                                             +2.7%
Nasdaq Composite                              -2.7%
Russell 2000                                       +1.3%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
The stock markets’ lateral journey has resulted in some very unique measurements in investor sentiment. As reported by the AAII (American Association of Individual Investors), bullish sentiment fell to its lowest level in over a decade at 17.75%.  One would naturally conclude if the percentage of bullish respondents fell, the number of bears must have increased.  Not to be – the bearish number also decreased from 34.1% to 29.4%!
The largest group in this week’s survey was the “neutral” camp which increased from 46.5% to 52.8%.  This is an astonishing event.  Going back to 1987 (or almost 30 years or over 1,500 weeks), there have been only 30 weeks where the bullish sentiment reading was below 20%.  Furthermore, there 28 weeks registering over 50% neutral.[i]
While this outsized neutral view is understandable given:
  • the U.S. economy is stuck in low gear
  • uncertainty surrounding profit growth
  • negative interest rates
  • the possibility of a rate increase in the U.S. in the next couple of months
  • untested monetary policies
  • terrorism
  • a unique and contentious political landscape in the U.S.
Further, this indecision is a sign of apathy towards the markets.  Again, this is reasonable after 2 years of stocks going nowhere combined with a 10% correction last August and the horrid start to 2016.
The debate among strategists and traders centers on how these worries get resolved.  The glass half full view suggests that these issues are already priced into the markets.  This argument holds that stocks could surprise to the upside even with modest economic progress.  Indeed, from a shorter term view, a couple of weeks ago stocks tested the lower level of the range at S&P 500 2,040 for the third time since March.  Sellers pushed the S&P down to 2,025 intraday on May 19th and it looked like the bears may finally gain control and take stocks lower.  Unexpectedly, the selling pressure dried up and stocks recovered before the close.  Equities rallied during the next few days and the S&P 500 quickly moved back to 2,100.
Perhaps the high number of “neutral” investors played a role in the failure of the bears to get the upper hand.  It’s hard to believe that these worried investors hadn’t already sold positions and raised cash.  Maybe there were no sellers left.
While this reversal was noteworthy as it snatched victory from the jaws of defeat, all we have accomplished is a move back into the upper part of the trading range.  Interestingly, when we look at returns after the previous times where bullish sentiment was below 20% and when neutral exceeded 50%, we see reasons for hope.  The S&P 500 has averaged a 6.81% return 3-months after a sub-20% bullish reading.  This improves to 13.26% 6-months after and 19.97% one year later.  Turning to the 50%+ neutral readings, the S&P averaged an 3.59% increase 3-months after hitting this threshold, a 7.67% gain 6-months later, and 19.94% in one year.
Based on sentiment only, we would look for a trading range breakout to the upside.  However, given the possibility of further gaffs from Donald Trump, an indictment of Hillary Clinton, a Bernie Sanders surge, or any other unexpected development, an upside move is far from certain.  2016 has been full of unexpected twists and turns with several very unique developments.  Maybe that is the new landscape and the markets continue to churn throughout the summer.

[i] The Bespoke Report, May 27, 2016

[i] Ibid, May 23, 2016
[ii] GaveKal Research, May 31, 2016

[i] LPL Research, May 24, 2016
Jeffrey Kerr is a Registered Representative of and securities are offered through LaSalle St. Securities LLC, member FINRA/SIPC. Mr. Kerr is an Investment Advisor Representative of and advisory services are offered through Kildare Asset Management, a Registered Investment Advisor. Kerr Financial Group and Kildare Asset Management are not affiliated with LaSalle St. Securities LLC.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is not indicative of future results. Investing
involves risks, including the risk of principal loss. The strategies discussed do not ensure success or guarantee against loss. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. Trading of derivative products such as options, futures or exchange traded funds involves significant risks and it is important to fully understand the risks and consequences involved before investing in these products. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional
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