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After 60+ days, the S&P 500 remains within its tight 6% range. While the pinball machine can be a bit agonizing, we can look towards history to get some perspective. In fact, it was not that long ago – a 90-day period from March to May of 2014 – that the market went through a similar 6% range- bound period.
So what feels different now? Is it the end of QE? The potential Grexit from the Eurozone? At this point, we have to imagine that we’ve all lost a bit of sensitivity to the usual post-2008 gloom and doom news cycle.
Perhaps – and we know this sounds a bit silly given that 2013 the S&P 500 was up over 30% and in 2014 it was up over 13% – it is a sense of waning momentum. When markets stop going up, everyone gets worried that they might go down. And worry can lead to panic and a rush for the exit.
A 200-day moving average can be a great tool to gain a sense of market momentum. We will measure the market’s “trendiness” as the slope of the 200 day moving average, also called its rate- of-change.
From March-to-May 2014, the slope of this average only declined by 9 basis points, from 14.42% to 14.31%. So while the market spent 90-days in a holding pattern, tailwinds remained strong.
At the beginning of December, this slope sat at only 12.60%; presently, it sits at 10.63%. The current range has caused a nearly 16% drop in trailing momentum strength. Much of this is due to October’s sharp sell-off and subsequent rally, more or less washing out another 30-days of return potential on top of the current 60.
But this rate-of-change decline has actually been more pervasive: we’ve witnessed a steady downtrend throughout the past year.
Part in parcel with this decline is the decline in distance between the S&P 500 and its 200-day moving average:
While these graphs seem ominous, it is worth pointing out that based on the trend-line drawn, price wouldn’t be expected to significantly pierce the moving average (i.e. the trend-line wouldn’t cross over 0) until mid-June 2016 and the rate-of-change wouldn’t turn negative until well after that.
On the one hand we have declining momentum strength. On the other, even if the trends continue, they indicate the market wouldn’t run out of steam for another year and a half.
Of course, when you take a longer look at history, it’s silly to infer anything from these sorts of models.
From 4/28/2003 to 1/10/2008 (the period over which the 200-day moving average had a positive rate-of-change in the last bull market), the average rate-of-change was 10.88%. The current rate-of- change sits at 10.63%. So while it has been in decline, it is likely just due to the absurd levels it had been elevated to during the 30% run in 2013. A similar story goes for the distance from the 200-Day Moving Average.
Our takeaway here is that while momentum has waned in the past several months, it was not unexpected. Markets do not move in a linear fashion: demand ebbs and flows and prices run-up and contract.
Consider this: at the end of December 2012, stocks pretty much ended up in the same spot they started the prior April at: 9 months of lost returns. The rate-of-change for the 200-day moving average was 4.03% and price was a mere 3.50% away. This consolidation period arguably set the stage for the massive price expansion in 2013.
We should not fear price consolidation: it is momentum’s natural complement.
In Our Models
Global equity momentum strength remains mixed. This week, we saw another sector fall into a neutral momentum rating, leaving 4 positive sectors, 4 neutral sectors, and 3 negative sectors. This resulted in a slight portfolio re-allocation.
In a range-bound market – like we’ve witnessed over the last 60 days – the neutral signals can help reduce whipsaw due to mean reversion. However, as our neutral signals serve as a transition point between positive and negative signals, it also means that the overall portfolio sits on the precipice of potentially introducing a modest amount of short-term Treasuries.