November of 2020 marked one of the best months for global equities in decades. A combination of U.S. election clarity, further U.S. COVID stimulus talks and a continuously improving global economic backdrop eased investor tensions, paving the way for a risk-on appetite. As I wrote in a prior article, Tech-Tock, Tech-Tock, the NASDAQ Index was largely being driven higher on momentum and less so on fundamentals, a similar phenomenon now occurring in other indices as well.
We are currently seeing indices inch forward with small gains leading to new highs on a near daily basis. Thankfully, the rate of participation in these indices is much greater than in the spring and summer of this year.
Looking at the occurrences where the S&P 500 Index had 90% or more of its members above their 200-day simple moving averages we see a beautiful thing. Essentially, we see the average forward return during these signals being equal to all points in time, or the unconditional reading, for the index. We see this until we look to the 1-year forward return time. At which point we are positive 98% of the time compared to only 78% of the time when looking at the index at any given point between the dates of 1996-2020. Not only this, but the average win exceeds double digits with a reading on 10.9%. This, all with a max loss of 5.5%! How can this be? After looking at the frequency of where these signals occur things start to make sense.
The chart above shows that we only tend to get signals, indicated by the vertical orange lines, before periods of consolidations that generally lead to continued bull market runs. Often these signals also occur after periods of large pullbacks in equities like what we experienced in March with the COVID-induced decline. To me this indicates we are in for relatively average market returns with perhaps relatively average volatility. This volatility will look and feel more extreme than in recent years as we have been conditioned to think stocks are always headed for the stratosphere.
Various macroeconomic and geopolitical factors could throw this hypothesis into array. The U.S. presidential transition has some holding their breath while China concurrently tightens its grip as a global superpower with the continuous freefall of the United State dollar. This, along with surging COVID infections could yank equities out of their current groove and start to turn the punch sour. In the meantime, all we can do is learn from our favorite teacher: history.
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Copyright © 2020 Ryan Preiss