Princely Returns For Investors Going Forward?

Once every quarter, Finom Group releases its weekly Research Report to the public. Now, let's go deep on this Super Bowl Sunday and see what the market has in store for investors/traders!

It is not always an easy task to remain optimistic about the outlook for the state of the economy or the stock market. Our weekly routines and defined processes can go a long way to achieving well-rounded investor psychology that isn't impacted by the wide array of headlines and price fluctuations. If there has been a better example of headline risk and price fluctuations than what was expressed over the past 2-week period, well, I'm all ears!

Just two weeks ago, the S&P 500 (SPX) fell some 3.3% and 4.5% from the all-time highs to give back all of the gains in January, and to squash the dreams of a January Trifecta. The January Trifecta, if you recall, would have claimed a positive Santa Clause rally followed by a positive First Five Day New Year rally and a positive return for the month of January, known as the January Barometer. But alas, January finished in negative territory. No, this does not spell doom and gloom for investors/traders. In fact, the January Barometer has more recently NOT led to declines over the next 11 months of the year. (LPL Financial table)

Going back to 2003, the S&P 500 has still been positive 88.9% of all years and the one year it was down occurred during the Great Financial Crisis. Let's also consider that two legs of the Trifecta did come to fruition and what that may portend:

  • Of the last 11 times since 1950 (last year, 2020 is the most recent) that the SCR and FFD were both positive (and the full-month January was negative), the next eleven months advanced 81.8% of the time and full-year advanced 72.7% of the time with gains of 8.2% and 4.1% respectively.
  • These are statistically significant results over a longer time frame and shouldn't be discounted.

The historic data/studies are here to inform investors of where the greater probabilities are to be found for capital returns. The data, however, is not here to determine the precision of returns or offer a guarantee of positive returns. Moreover, and as Warren Buffett has been known to say...

With that being offered, indeed the market had a determined and strong rebound from the previous week's decline.

Markets Go On a Wild Ride

I do find favor with so many of Warren Buffett's quotes over the years. They are so well-rooted in the understanding of what markets can help the average investor achieve if only they look at downturns the way they look at a sale from Macy's (M).

"Look at market fluctuations as your friend rather than your enemy. Profit from folly rather than participate in it."  ~ Mr. Buffett

This should be where we pick-up our weekly Research Report, in my earnest opinion; after coming through a decline of 3.3% two weeks ago only to rally more than 4.65% this past trading week. Again, in my earnest opinion! When the heat gets turned up on the market, it seems that sentiment can shift rapidly and market participants start leaning toward the direction of price with their sentiment. This is especially the case when the price draws lower. Your one job as an investor is to simply afford yourself the time to become friends with market drawdowns, to see them as your friend/opportunity. Drawdowns have to be part of an investor's/trader's expectations and recognizing that we must...

Plan trade with entry > set goal/s for trade > achieve trade objective = discipline/process

The aforementioned is what I often refer to as my PSA to all traders and investors, my Public Service Announcement: Plan, set goals, achieve objective! You'll know if you're process is successful or demands refining and course correction by the ability to achieve repeatable profits. Now, about those corrections and sentiment suggesting, "We must correct 10% or greater because... XYZ!"

Most strategists have been warning or calling for a 10% correction since last November, yet here we are. Every week someone is marched out on CNBC touting a 10%+ correction due to XYZ. I'm not in the business of saying they will or won't be proven right or wrong. I simply don't care. It does not affect my investor psychology what a hedge fund strategist offers as he aims to predict the future. Were he/she found with such a skill, I'd much rather him/her disseminate the Lottery numbers. But alas!

I think what can often get missed or overcome by the noise of these prognosticators is the fact that MOST stocks have already corrected 10% or greater. The chart above from Thrasher Analytics from January 28th identifies this point of fact. Remember, it's a market of stocks folks! The S&P 500 was down 3.3% two weeks ago, but 55% of stocks were already off of their highs by 10% or greater... already, already!! (middle panel above) By Friday, January 29th, the percentage of stocks 10% or greater from their highs grew to 60 percent. Just saying, underneath the surface of the index, price had proven a much greater correction than many had assumed. This is something that we discussed in the Finom Group Trading Room with members.

One of the 2021 "talking head" themes centers on the notion of market bubbles and how the stimulus is creating such a bubble. If there has been a bubble in anything its been the heralding and hyperbolizing of the stock market as representing a bubble. Look at the Google Trend search results below:

I refer to these types of people who engage in such discussion as "quacking ducks". I've no intention of feeding these ducks. My only objective as an investor is to achieve a return on capital. This doesn't mean I completely ignore the quacking, it simply means I need to remain informed and with a greater focus on the task-at-hand, investing capital and due diligence efforts. What I've seen in my 22 years as an investor, analyst and strategist is that the financial media likes to maintain quacking duck issues at the forefront and for the most part, they lose sight of what is really going on with the stock market. What is nice to see these days, however, is a stock market that isn't paying a lot of attention to politics or any other background noise for that matter. Instead, the market is paying attention to economic data and corporate earnings. Over time, these are market driving forces. Alright, lecture of the week from Prince Akeem is over with, let's go look at some charts! I've astutely labeled the coming segment...

Some Charts

My first chart will not necessarily come from the indices, although we'll certainly get to those, but rather from investor sentiment readings. (Bespoke Investment Group)

The latest sentiment survey from Investor's Intelligence, which surveys newsletter writers rather than individual investors, showed that  Bullish sentiment in this survey came in at some of the lowest levels since the fall. At 57.8%, it was the first sub-60% reading since mid-November and the lowest reading since November 4th. Bearish sentiment was slightly higher rising to 16.7% from 16.5% though it is still below levels from two weeks ago. While these survey results still lean historically bullish with the bull-bear spread at 41.1—which is in the top decline of readings going back to the 1960s—a higher share of respondents did report that they are looking for a correction. That reading climbed above 25% for the first time since the first week of November.  While that is far from a historically high reading (historical average of 25.77%), it did end a streak of consecutive readings below 25% at 12 weeks long.

Across the history of the survey, there have been 42 streaks of readings of "looking for a correction" below 25% that lasted for at least 12 consecutive weeks. In the table above, it shows the 14 of these instances that occurred without a prior occurrence in the past year. While it is just one particular study, it does suggest some choppy to potentially downward price action near-term. Let's remember, however, that there are many, many inputs to consider and the historic data is not a guarantee as we saw in this study below, which I discussed in Finom Group's weekly State of the Market:

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  • Here are all instances of the S&P 500 falling -3% or more during an uptrend (i.e., positive returns over the trailing 12 weeks) that closes within -10% of our all-time high weekly close. (Since 1990)
  • Study from Steve Deppe CMT as of the week of January 25th.

If we look at the study of when the S&P 500 falls -3% or more during an uptrend, the 1-week forward returns are negative by a median of -.40%. The positivity rate 1-week later is also only ~42%, and yet the market rallied 4.65% after this signal. Just another example of staying informed so as to maintain appropriate expectations, but remaining flexible to a wide variety of outcomes.

As it relates to all the "market bubble" characterizations, here is something else that Bespoke Investment Group offered to help evidence just how healthy this "best ever" bull market has performed. In a 2019 tweet, Allstarcharts founder and CMT J.C. Parets foreshadow:

Don't miss this point for validation's sake. If we want to dissect the difference between a healthy bull market and a "propped" bull market, sector performance is a healthy tool. Sector rotation throughout the rally off the March lows has been incredible.  In each of the 5 acts in this bull market, the only sector that hasn’t been a leader in at least one of the acts has been Real Estate.

Now, step back and think about how this bullish, continuous sector rotation of leadership has also been seen in other indicators. If sector rotations are a sign of a healthy, if not vibrant bull market, where else would it show up? That's right, it would show up in the percentage of stocks trading above key moving averages and in advance-decline lines (A/D lines). It would also show up in the way of many if not all market cap weights moving on-trend.

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