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History Shows Bears May Continue To Be Frustrated

Daily State of the Markets
Monday, August 5, 2013

Good Morning. With the stock market, as measured by the S&P 500, continuing to confound the bears and finishing Friday at fresh all-time highs, there is little doubt that the bulls remain in charge of the game at the present time. And for anyone wishing to argue with me on this point, I present (a) the charts of the S&P 500, DJIA, and NASDAQ, and (b) the fact that the S&P is now up +19.9% year-to-date, the NASDAQ is up +22.2%, and the Smallcap index (NYSEARCA:IWM) has gained +24.7%. Not bad for a year in which the world was supposed to end.

It is also worth noting that the attempts by the bears to derail the bull train have been largely unsuccessful so far this year. Sure, the market paused when Cyprus made headlines. And yes, the "taper tantrum" in May/June did produce a garden-variety pullback of -5%. But beyond that, it's been the bulls' ballgame this year.

In fact, the +18.2% year-to-date gain for S&P 500 through July 31, qualifies as one of the best first-seven-month gains in history. According to the computers at Ned Davis Research, the 2013 gain through July is the best since 1997 and the 11th best since 1929. No wonder the bears are frustrated!

The question, of course, is where do we go from here? The bear camp is howling about another overbought condition and the fact that valuations are beginning to move away from fair value. The glass-is-half-empty gang also continues to moan about the idea that the Fed's ZIRP (zero interest rate policy) is the only thing keeping the indices afloat. Thus, our furry friends contend that the current rally is not going to end well and that we should be bracing for a replay of 2008.

As I've mentioned a time or twenty, we don't play the prediction game at our shop. No, we like to be opinion-agnostic and merely try to stay in line with what the market IS doing at all times. This approach does get us whipped around a bit when the market is in an "iffy" state, but it also keeps us on the right side of the market's really important moves, the vast majority of the time.

However, it is also nice to have some sort of idea as to what to expect next. So, this morning I thought we'd look at the statistics on what strong gains from January through July tell us about the coming months. And then tomorrow, we can revisit the cycle composite to see what the cycles say about August.

Since the end of World War II, a gain of at least 15% for the S&P 500 through the end of July has been a good omen for the rest of the year. Of the twelve times the S&P has put up gains of 15% or more in the first seven months of the year, the market has finished higher at the end of the year eleven times, or 91.7% of the time.

Although the 1987 case skews the stats a bit, the average gain for the following five months of the year after a gain of 15% in the January through July period has been +4.3%. And if we take out the 1987 program trading-induced disaster, the average increases to +6.7%.

However, in doing the math one thing jumped out at me. Over the August through December periods, the gains tended to be either small or significant. For example, of the eleven cases we reviewed where the market finished higher after a strong seven-month start, the S&P finished the ensuing five months higher by less than 2% on five occasions. And for the six cases when the market was stronger during the August-December period, the average gain has been nearly +11%. In other words, after a strong gain in the first seven months of the year, history shows the bulls either continued to romp - or - limped home into the end of the year.

On a near-term basis, the stats are less conclusive and also less encouraging. Since the end of WWII, the S&P has only been higher during the month of August 42% of the time and has only been higher three months later one-half of the cases. Thus, in short, it looks like August could be a toss-up.

However, looking longer term, the first seven-month surge appears to have lasting benefits for those holding stocks. Since 1929, the S&P 500 has been higher over the next six months 72% of the time. And then looking out a year, the market has finished higher 83% of the time since the end of WWII and sported an average gain of nearly 12% during the period.

To be sure, history rarely, if ever repeats. However, in the markets, history often rhymes with near-term events. As such, it appears that if the bulls can muddle through that last summer month, they could be rewarded going forward. Granted, the pace of the gains is likely to slow. But the key is that if history can repeat to some degree, the bears may continue to be frustrated.

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Turning to This Morning...

Although the most recent data out of China on the state of the services sector surprised to the upside and the European Services PMIs weren't half bad, markets in Europe do not appear to be in a celebratory mood. As usual, the U.S. futures markets are following Europe's lead and point to a modestly lower open on Wall Street. However, U.S. traders will get some important input at 10:00 a.m. eastern time when the U.S. ISM Non-Manufacturing data is released. In addition, we will get a fair amount of Fed-speak this week as various Fed officials are slated to present their views.

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell...

Major Foreign Markets:
- Japan: -1.44%
- Hong Kong: +0.14%
- Shanghai: +1.01%
- London: -0.10%
- Germany: -0.08%
- France: +0.16%
- Italy: -0.21%
- Spain: +0.13%

Crude Oil Futures: -$0.97 to $105.97

Gold: -$4.40 to $1306.10

Dollar: higher against the yen and euro, lower vs. the pound

10-Year Bond Yield: Currently trading at 2.628%

Stock Futures Ahead of Open in U.S. (relative to fair value):
- S&P 500: -3.05
- Dow Jones Industrial Average: -24
- NASDAQ Composite: -1.92

Thought For The Day...

Life is a great big canvas, and you should throw all the paint on it you can. -Danny Kaye

Positions in stocks mentioned: none

Follow Me on Twitter: @StateDave


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