As the saying goes: Fool me once, shame on you; fool me twice, shame on me. When it comes to stocks, it looks like the market is fooling everyone not once or twice or even three times. No, this is the fourth year where the S&P 500 (SPY) seems to be following a script:
2010, 2011, 2012 and now 2013 have all started fast, with a rally out of the gate and no looking back for at least two weeks. The chart above shows the first 13 trading days of the year - 2013 (green) was the best first-day jump, and it is tracking 2012 (yellow), with the market up the same 4% roughly YTD after the first 4 weeks.
A start like this can be frustrating for those not involved or, worse, short. Do you jump in (or cover), or do you wait for a pullback? If you waited in 2012, guess what: You are still waiting! 2012 was quite unusual in that the market NEVER looked back. You can see this in the chart below, which has the rest of the year charted for the last three years:
In 2011 (orange), waiting was frustrating too. You had to wait until 50 trading days for the market to return to its start, and you had to move fast. You got another chance in June of that year. 2010 broke the 2009 close pretty fast, but it should be considered in context: 2009 was a huge rebound year for the market, so profit-taking wasn't too surprising. With a moderate rally in 2010, it took a while before profit-taking kicked in. It would seem by this line of thinking, we might not get a pullback very soon in 2013 either.
I remain optimistic about the market, expecting that 2013 will play out like 2012. By this, I am suggesting modest PE expansion on top of modest earnings growth. The combined effect could lead to all-time high levels on the S&P 500, which would mean eclipsing 1576, the peak in 2007. I am on the record with a 1664 projection, which is 14.5 x what I think projected 2014 EPS will be at year-end.
Whether we get the dip below the 2012 closing level or not, the last three years, oddly, have all seen interim peaks late in Q1 or early Q2 (March/April), and this lines up with my forecast for this year. Two things guide my thinking here. First, the rally isn't yet extended. I tend to focus on the crossover of the 10dma and 50dma in the context of both being above the longer moving average (I use 150dma, but 200dma gives the same info). I have found that these trends get extended after about 13 weeks or so, which suggests early March until the market gets risky from this perspective:
The 50dma (in red) is rising and already, at 142.51, higher than the 142.46 year-end close. The second thing I look for technically is whether or not the market is overbought. Many people think about this differently, but, what I do, is contemplate how far we are from trend. There are many ways to calculate this -here is an easy one. The 10dma is currently 146.90, which represents 104% of the 150dma. That's not too far ahead of trend! I would be concerned at 110%. Another way to look at it might be to consider that we are just barely higher than the September highs more than four months later.
So, given that we aren't particularly overbought or overextended, it would seem that the path of least resistance, which is up, should persist, at least for the next couple of months roughly. The new seasonals, if they exist, would suggest not fighting the tape as well.
It's fun to think that there might actually be a tradable seasonal trade, but we know that these things work until they don't. I have given some thought as to what some of the factors driving the last four years of out-of-the-gate rallies might be (and why they run out of steam in March/April). The three things I am coming up with are risk appetite, Q2 earnings fears and taxes.
The first factor is appetite for risk, especially in an investing world increasingly dominated by hedge funds. These things are hard to prove, but after the 2007-2009 bear market, it seems like investors have continued to be fearful in the middle part of the year every year. It seems to start in Q4 each year and accelerate into the new year. One way I measure this is to look at how Small-Caps are performing relative to Large-Caps. December provided strong evidence of a higher appetite for risk, with the Russell 2000 (IWM) up 5.56% compared to the S&P 500 up just 0.91%. This persists into 2013, as IWM has a slight lead over SPY so far (5.14% to 4.28%). We see this reflected as well in sector leadership, with low-beta Utilities and Telecom services performing poorly.
If increasing risk appetite explains the strong Q1 in this new normal world, what explains the sudden halt as Q1 is ending? One factor may be as simple as Q1 earnings season or a fear of Q1 earnings season, as the relatively weak economic growth over the past few years has left the full year outlook suspect. In each of the past three years, perhaps for different reasons, the weakness has persisted into the summer if not all the way to Labor Day. 2012's summer low came pretty early, before the official start of summer actually (the first week, right after Memorial Day).
I think a more interesting idea is the notion of selling stocks to pay taxes that are due 4/15. Again, these things are hard to prove - it's just a theory. 2013, though, could be quite interesting on this front, as many investors harvested gains late in 2012 in front of the rise in long-term capital gains. To the extent the taxes weren't set aside, we might see some selling late in Q1 or early Q2 to raise cash.
The fact that the market has been strong in each of the past three Q1s is interesting, but not necessarily explicable and certainly not a sure-fire forecasting tool. For those who are on the wrong side of this fourth year of a quick start, it would seem like the odds of a sustained pullback in the very near-term are low. Fundamentally, it appears that the economy has more resilience post-cliff than many had expected. Valuations remain reasonable if not low. Many parts of the market are breaking to all-time highs, like the Dow Jones Transports, Mid-Caps, Small-Caps and Biotech. Bottom-line: I'll go with the new seasonals!