- A sideways-trending market, signaling a fierce bull-bear tussle beneath the surface, may mean a new dynamic is coalescing.
- Given this dud of a first quarter, it’s getting late early, as the oracle Yogi Berra once said.
- The pressure is on April and May to give the market some momentum before we head into the summer doldrums.
The stock market's inability to get going this year is frustrating bulls. In our view, bulls should be careful what they wish for, as the path of least resistance seems to be downward.
We regard the market's three-month sidestep as more worrisome than a clean break lower would have been. When a market breaks a clear trend with an extended sideways movement, we always assume the new trend, when it comes, will be opposite of the prior prevailing pattern. A clean break lower off 2013's rally year might have been a buyable dip, or a healthy consolidation beneath the next leg higher.
A sideways-trending market, signaling a fierce bull-bear tussle beneath the surface, may mean a new dynamic is coalescing. Bulls have the numbers and last year's momentum, but are frankly looking complacent. Bears have conviction, but have yet to demonstrate the weakening data to back that conviction.
Dusting off the Record Book
What a difference a year makes. As March 2013 gave way to April, investors were high-fiving one another. The S&P 500 rose 10% in the first quarter of 2013, which was better than the full-year performance for 14 out of 33 years on the index since 1980. The S&P 500 went on to deliver 30% capital appreciation and 32% total return in 2013, making it the best year of the bull market that began in March 2009.
This year, the S&P rose about a percentage point in 1Q14, after coming into the final two trading days dead even with the opening level. The slight win in the first quarter reflects relative quiescence among Russian troops mulling about the Eastern border of Ukraine. Even though the market barely missed a negative 1Q, there is little to cheer about 1Q14. We have all heard about the January effect; could there be an equally onerous first-quarter effect?
Consider that in the 34 trading years between 1980 and 2013, the S&P 500 has averaged 2.7% capital appreciation in the first quarter and 9.6% capital appreciation for the full year. Carve out the down first quarters, however, and the picture is not so pretty. The eleven negative first quarters on the S&P 500 since 1980 have been precursor to an average 0.9% decline in those eleven full years. Of course there are a few distorting years in the mix. The year 2002 was fractionally negative in 1Q02; toss out 2002, and the full-year capital appreciation for those 10 years with down first-quarters swings to a positive 1.4%. Still, that is a far cry from 9.6% average gains for 1980-2013 overall.
Rather than being negative, 1Q14 was one of those periods in which the market did not move conclusively in either direction. Before we get to why the market is standing still, what can we learn from those three years in our survey period - 1981, 2002, and 2007 - when the S&P 500 finished unchanged on March 31 from the preceding year-end? In retrospect, we can see that those were all recessionary years: in the middle of recession in 1981, readying to exit recession in 2002, and on the cusp of an historical downturn in 2007. That should certainly give pause. But there are no signs of a purely economic recession on this year's horizon.
Why should we care what the market did in those distant years? We never set our course by past performance. But experienced traders are aware of past trends and seasonal patterns. Traders and investors are not looking to blaze trails; they're looking to do what everyone else is doing, just one step ahead. With this mentality setting the course, any market falling into a familiar pattern risks locking in a well-worn trend.
The Current Environment
Blowing the dust off the history books only takes us so far. Why is the market standing still this year? Maybe we can start by wondering why the stock market hasn't tanked this year. The most important growth engine of the past decade, China, has stalled. And Russia is acting with impunity in Ukraine.
China is our second largest trading partner, accounting for 14.6% of 2013 U.S. total trade, according to U.S. Census Bureau data. But China, while providing us with 19% of our imports, accounts for jut 8% of our exports. Our largest trading partner, Canada (16.5% of total trade) and our second-largest, Mexico (13.2% of total trade), each has a better balance of imports and exports; and both are meaningfully larger importers of our goods. A struggling China is not at risk of losing its appetite for our goods, because it has never had much appetite for our goods. Bottom line: China's recent stutter-steps are unlikely to meaningfully impair S&P 500 earnings prospects this year.
Before becoming too shocked by Russia's incursion into Crimea, it is worth remembering that Russia has always acted with impunity in Ukraine. The period between the fall of the Berlin Wall and the 2014 Winter Olympics was the aberration in Russia's relation with its neighbor, not the other way around. And Crimea has often been seen as part of Russia. In 1954, the Soviet Union transferred Crimea from the Russian Soviet Socialist Republic (SSR) to the Ukrainian SSR with a single-paragraph decree.
In the U.S., the takeover of Crimea has set off a round of party politics. Partisan bickering lessens the likelihood of a unified response, while serving as a cover for increasingly isolationist tendencies that erode our role as "global cop." The evolving U.S. realpolitik borrows from Europe, where Russian belligerence is nothing new and where individual nations are watching their own borders without promising to safeguard anyone else's.
If Russian imperialism and Chinese deceleration are insufficient to send the stock market lower, something must be propping it up. Stock market appreciation correlates with earnings growth; we continue to model high single digit EPS growth for the S&P 500 for the next two years. On the economic front, domestic economic data is improving, as we have detailed recently. Tapering of QE is a sign of Federal Reserve confidence in the economy, while steepening in the yield curve is a sign of investor confidence in economic acceleration. As winter recedes, the U.S. consumer seems to be feeling better. Europe appears to be stabilizing, and we are seeing a broadening in emerging economy growth (albeit at the expense of China).
Now that 2014's going-nowhere first quarter is over, April is here with its history of better returns. April has averaged 1.61% capital appreciation since 1980, second best of any month (behind December) in the that 33-year time span. The 1Q14 reporting season starts around mid-April, providing CFOs an opportunity to look ahead - too frequently offering best possible outcomes from behind rose-colored glasses.
As the working year plays out, reality intrudes in the form of bad weather, geopolitical events, cautious customers and fickle consumers. CFOs hedge their formerly too rosy guidance. That may partly explain why the summer months of June, July, and August have barely averaged a 50% win rate on the S&P 500 since 1980.
By the time August is over, we are eight months into the year. Given this dud of a first quarter, it's getting late early, as the oracle Yogi Berra once said. The pressure is on April and, yes, even May, to give the market some momentum before we head into the summer doldrums.