Is It Safe To Ignore Seasonal Patterns In 2017?
The holiday-shortened week saw most equity indexes suffer the second worst weekly losses of the year. Escalating military tensions in North Korea and Syria and growing uncertainty over the future of Donald Trump’s growth agenda provided the nominal reasons for the selling over the past days. The VIX finally broke our alert level this past week, crossing above 15 and ending the week at 15.96…the highest close on the volatility index since November 8, 2016, U.S. election day. Despite the movement in the fear index, a sign that investors are beginning to use options protection, the S&P 500 is still less than -3% off all-time highs. The break-out in the 10-year U.S. T-Note perpetual contract to news 4-month highs and spot gold prices finishing the week at the highest close since prior to the election confirm that the risk-off trade is rising from the ashes.
After the final leg-up of the post-election equity rally in February, U.S. equity indexes have stagnated now for 6-weeks. During this time, many market pundits have been calling for the “-5% correction” in the S&P 500. We believe one on the reasons that U.S. equities have remain aloft for so long since the election is the general disbelief in the rally among cautious investors not wanting to get trapped once the speculative frenzy ends. Given the powerful post-election rally, we should not be surprised that more time was needed to work off the (near) euphoric mood of investors. It is often said that market tops are a process, and currently the process has taken 6-weeks thus far (counting from the March 1 st high on the Dow).
As we move towards the summer months, equities enter a period that, historically, has seen seasonally weak equity returns. While the “Sell in May” mantra will be heard in the financial media should U.S. equity indexes continue to roll over, the success of this investing maxim has recently had the success of a coin toss. Should investors disregard seasonal patterns again this year? With the bull market now 8-years old – the second longest bull market in history – we are less concerned about seasonal trading patterns from an asset allocation point-of-view. Whether selling begins in earnest in this month, in May, in June, or not until October, we recommend not being too complacent in “buying the dip” on the belief that we are getting a garden variety period of seasonal weakness. While no one can predict today if this bull market will end in its eighth year or not until its tenth year, buying a shallow seasonal dip this summer on the hopes of a rebound may turn out to become a “long-term position” (and not in the good sense).
In this week’s Commentary, we review the path of key U.S. equity benchmarks thus far in 2017 and compare current price action to historical seasonal patterns. We also highlight several sectors that we are watching relative to their typically seasonal trading patterns.
Most equity indexes got off to a positive start in January of this year. We trace two seasonal trend lines in our charts below. The black lines show the historic composite path of the index over all years, while the blue lines consider just the years when the index got off to a positive start to the year. Known as the “January barometer”, this trading rule states that the first week of the year (or the performance over the month of January) is a barometer for the index’s performance for the entire year. Admittedly, the January barometer has a mixed track record, but we offer the seasonal performance (based on whether the first week of the year was positive for negative) for the sake of comparison.
Dow Jones Industrial Average
The overall seasonal pattern in the Dow (black line) clearly shows that the first quarter and the fourth quarter tend to produce strong positive returns, while the Dow has tended to stagnate in the second and third quarters. For the Dow, a positive January barometer has tended to predict a stronger-than-average year for the index, as shown by the rising blue line throughout the second and third quarters (compared to the flattish all-period black line). The current year Dow price action is shown by the red line. Visibly, the Dow is currently diverging from the seasonal pattern, after tracking the blue and black lines closely through week 10/11 of the year. We may be getting an advanced warning that 2017 won’t play out in accordance with historical seasonal patterns.
S&P 500
For those who refute the January barometer, the S&P 500 price data over the past 38-years offer a strong case that performance in the first week of January is a good indicator for the year. The blue line (containing price data only for years when the S&P 500 began the year positively) significantly diverges from the black line, containing price data for all years.
So will 2017 will be another blow-out year for U.S. equities? Perhaps. But at the moment, the slight divergence of the red line over the past 5-weeks merits watching.
Nasdaq-100
Tech has been on fire in 2017. And the Nasdaq-100 index has been tracking perfectly its seasonal price patterns. Bulls can take comfort in the seasonal price action of tech stocks thus far in 2017.
Russell 2000
Yes, there is something very concerning with the seasonal price chart for the Russell 2000 small cap index. After starting 2017 on a positive note, the Russell has grossly diverged to the downside. When riskier small caps underperform bull chip stocks, we typically experience unfavourable periods for equities in general. We are bearish on small caps for a host of reasons, not the least of which being poor performance relative to seasonal trends.
We share our seasonality charts for several sector indexes which are standing out this year. Our complete list of weekly sector seasonal charts is published in our Models section.
S&P Financials Index
The financial sector was tracking almost perfectly its seasonal price pattern up until week 11. For the past five weeks, banks have fallen out of bed…with a thud. We predict that banks won’t be able to find their way back in line with their seasonal trends this year. Banks are a sector we would not touch this year, after their +165% annualized move between November 2016 and February 2017!
S&P Energy Index
Another sector that we are following closely is the energy sector in general, and more specifically the oil & gas exploration and production (E&P) index. After a -13% sell-off in West Texas crude oil in March we have seen, surprisingly, an equally rapid bounce in oil prices in April. West Texas crude is again near March highs at $53/barrel, leaving a series of higher troughs in the price since the February 2016 low, and a still bullish configuration on the charts. With prospects for stronger U.S. and global economic growth, a pro-energy U.S. president, OPEC finding some agreement on production cuts, and geopolitical tensions in the Middle East, we see more tailwinds than headwinds for oil prices going forward.
Historically, the S&P 500 Energy Index has gotten off to a slow start to the year, as shown by the blue line below. The initial weakness in energy prices this year was in-line with seasonal patterns. However the negative divergence with respect to the seasonal trend over the past few weeks has left the energy index about -10% below its seasonal trend patterns after the 15 th week of the year. Are energy stocks an opportunity or a trap this year? The energy SPDR (XLE) is still in a downtrend from the December 2016 swing high and the price is only 1.5% above 2017 lows. Currently in a period of favourable seasonal tailwinds, we remain on the lookout for a bullish reversal in the energy index. We recognize that, with the E&P stocks (XOP) still -55% below 2014 highs, this is much more potential for long-term investors in energy than, say, a sector such as technology (IYW) which is now trading +120% above the prior bull market highs.
NYSE Gold Miners
The gold miners, like energy, are one of the few sectors that have not run-up to all-time highs over the past few years. The underlying reasons for including gold in a portfolio are not missing: safe haven store of value; inflation hedge; alternative to major currencies being devalued by QE-obsessed central banks. But in an extreme risk-on market, taking a “hedge position” in gold has been regarded as an unnecessary drag on portfolio performance. In another potentially positive development for gold, Donald Trump last week lamented about dollar strength (a rare occurrence when the U.S. president talks negative about the dollar). If Trump decides to keep talking about dollar strength, this can only be positive for gold.
Gold has rarely been this cheap relative to financial assets, meaning that the upside potential in gold is enormous. We believe a break-out in gold is imminent. On the first chart below, we see that gold is testing an amazing 6-year resistance line. While gold failed to break this resistance line in 2016 as we were expecting (eroding early 2016 gains in our gold miner positions), the more often a resistance line is tested, the higher the probability that the price will break though. And when gold finally breaks though, gold will be off to the races.
The gold miner stocks, which have a 0.85 correlation coefficient with the gold price and a 0.05 correlation coefficient with the S&P 500 (the miners are completely decorrelated with broad market stocks) have earned the title of “most unloved asset class” since 2011. From 2011 peak to 2016 trough, the NYSE Gold Miners Index fell over -80%. From Friday’s close, a hypothetical return to 2011 levels would still imply a +150% gain on gold miners. As for the seasonal trend, the 2017 price behaviour of the NYSE Gold Miners Index (in red) is tracking very tightly its historical seasonal pattern (in blue). We are currently in a favourable seasonal period for miners. We invite investors to participate in the gold miners uptrend over the next couple weeks as the gold price threatens to break above a major, multi-year resistance line.
Conclusion
U.S. indexes have muddled along since hitting post-election highs on March 1 – almost as if waiting for the seasonally unfavourable period (traditionally starting in May) to kick-off the next down cycle. With the Dow, S&P 500, S&P 400, and Russell 2000 charts currently putting in a lower April high relative to March (the Nasdaq remains a stand-out, hitting a new high in April), just as we arrive at the seasonally unfavourable period of the year, we recommend resisting the temptation to buy into weakness in the coming weeks. The widely predicted -5% pull-back is just too predictable….markets of late have not been following the script of the “consensus guesses”. An old investing dictum says “it’s better to out of a market wishing you were in than being trapped in a market wishing you were out”. We expect this dictum to hold true in the coming weeks and months.
