As we explained in our most recent market commentary, The Unloved Rally of 2016, investors have aggressively trimmed their equity holdings to buy bonds with record low yields. We showed that, while this contrarian sign is typically supportive for the stock market, it had not coincided with large gains this year. As the U.S. election approached, we reevaluated our stance of owning maximum equity investments in each of our portfolios. Our decision to maintain the bullish posture is partly based on historical precedence for similar trading ranges in past market environments.
The chart below compares the value of the S&P 500 index (in the top clip) to its 2.5-year range (bottom clip) going back to 1928.
At the end of October, the 2.5-year trading range for the S&P 500 was less than a 20% – a very tight window which has occurred only twice since the beginning of the chart. The top clip shows the two historical comparisons as the shaded vertical gray lines.
Why might extended trading ranges coincide with outflows from US equity funds? Fatigue. Like patrons leaving a long, slow-moving line at an amusement park; many investors became impatient with 2.5 years of stagnant equity returns. To many, the extraordinarily long wait for positive U.S. stock returns feels magnified after becoming acclimated to the quick pace of the market recovery since 2009.
Because only two equally tight trading ranges have occurred since 1928, we look to those examples for clues about future market movements. The chart below highlights the two historically low trading ranges and the returns that followed.
The red and grey lines illustrate U.S. equity performance during the prior two examples. The blue line represents the current trading range up through October 11th, 2016. As can be seen, the previous multi-year consolidations were resolved with explosive upside breakouts. While this may not repeat for a third time, the recent upside breakout since the election could be a sign of more to come.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. All investing involves risk and no strategy assures success or protects against loss.