Most investors are aware of the market’s various seasonal patterns.
In the Four-Year Presidential Cycle the market has a strong tendency to be positive in the last two years of each Presidential term. Within each year it tends to make most of its gains in its annual favorable season between October and May. Shorter term, it tends to be positive in the few days surrounding the end of each month.
Not as many are aware of the tendency for the market to run into trouble, even within its favorable annual season, when February rolls around.
Februaries have been particularly troublesome since 1999. It has been a down month in 8 of those 13 years, with an average decline of 4.3% in the down years.
But even that doesn’t tell the whole story. Obviously, a decline doesn’t start on the first day of February and end on the last day of the month each year. So even in years when February was an up-month it was still often involved in a period of market trouble.
For example, February was a positive month in each of the last two years, with the S&P 500 up 3.1% for February in 2010, and up 3.4% in 2011.
However, in 2010 the weakness came early, a 3-week market correction of 7.9% beginning January 19 and ending February 8. Last year the weakness arrived late, with a four-week 6.2% correction beginning February 18 and ending March 16.
So far this year there has certainly been no trouble. In fact, it’s been unusually smooth sailing, with none of the frequent, heart-stopping 200 to 400 point moves by the Dow in both directions that were experienced in the summer and fall. As of the close on Thursday the Dow has had only two days of triple-digit moves this year, and both were to the upside, a gain of 170 points on the first trading day of January, and a gain of 156 points on the 2nd trading day of February.
But there are now yellow flags waving, indicating the need to be alert.
They include that the extra exuberance of the best January in 15 years has the market quite overbought technically above key moving averages.
Then there is the high level of optimism and bullishness among investors. It’s no secret that investor sentiment tends to be very bearish at market lows and then gradually improve until it reaches extreme bullishness by the time rallies have been underway for some time, have made new highs, and may be ready to top out.
We can see that condition in several methods of measuring sentiment. This week’s poll of its members by the American Association of Individual Investors showed another jump, to 51.6% bullish and only 20.2% bearish. Historically, the AAII poll is considered to be in its warning area when bullishness reaches above 50% and bearishness drops below 20%.
The VIX Index, also known as the Fear Index, measures the sentiment of options players, and is another consistent method of measuring investor sentiment. It showed a very high level of fear or bearishness during the summer correction and at the October low. But as the rally off that low has progressed fear has disappeared, now measured at only 19 on the VIX Index, in the zone of low fear (high bullishness) usually seen near rally tops.
We also have to consider the high level of selling by corporate insiders. Corporate insiders, blessed with more information about the prospects for their companies and those of competitors than any outsider could possibly obtain, have a history of successfully buying near market lows and selling near market tops.
In the month of November as the market plunged in its first sell-off in the rally, insiders began buying heavily, at a ratio of 100 shares bought for every 80 sold according to Argus Research. But now insiders are selling at a heavy pace, a ratio of almost 600 shares sold for every 100 bought.
None of these conditions, an overbought market technically, a high level of bullish investor sentiment, a high level of insider selling, can trigger a sell signal. They can only warn a top could potentially be near. The market can always become more overbought, sentiment can always become more bullish, and insiders can continue selling.
But the combination of those conditions and the arrival of February should be enough to have investors alert, and at least cautious about wading further into the market for the time being.
