Having grown up in the NY/NJ area, I’m a huge NY sports fan. However, I landed on the wrong side of the NY sports divide line: My mother grew up in Queens, so I inherited the Mets and Jets side of the aisle. Both of these franchises have been inept for the bulk of my 37 years, but the 2006 Mets were totally magical. A lineup that included sluggers like Carlos Delgado, Carlos Beltran, and David Wright. A speedster like Jose Reyes (Jose! Jose! Jose! Josee!), role players like Endy Chavez, who still to this day has one of the greatest catches in MLB history, and a pitching staff that included Tom Glavine, Pedro Martinez, “El Duque” and Billy Wagner. This team was totally unbeatable, and I was convinced they were going to win the World Series.
Fast forward to game 7 of the NLCS against the St. Louis Cardinals. The Mets trailed 3-1 entering the bottom of the 9th after Yadier Molina homered in the top of the 9th to give the Cardinals a 3-1 lead. The Mets then put runners on 1st and 2nd with nobody out, sending the game-winning run to the plate. Cliff Floyd then struck out, Jose Reyes lined out to CF, but Paul Lo Duca drew a walk to load the bases and it brought Carlos Beltran to the plate. Beltran had signed a 7- year, $119 million contract with the Mets the year prior, and he just had a monster 2006 season, batting .275 with 41 homers and 116 RBIs. A single to right would tie it, a double to the gap would end it, and it was Mr. Beltran one-on-one vs. Adam Wainwright. Unfortunately for me, and every single Mets fan across the globe, Adam delivered a nasty, nasty curveball. Beltran didn’t even get the bat off his shoulder. He clearly got caught expecting one pitch, but Adam gave him another.
What does this have to do with the S&P 500? Well, the S&P 500 just delivered its own nasty curveball in the month of May. The index opened May 1st by trading up by 0.28% relative to April 30th’s close, and set a fresh new all-time high, but then closed exactly 0 trading days in positive territory for the entirety of the month (i.e., every daily close in May was below April’s monthly close). The index has now declined four weeks in a row, and there wasn’t a single positive week recorded in May. The S&P 500 traded down as low as -6.63% from April’s monthly close and showed absolutely no strength into month end, something that was the norm during 2018’s most volatile calendar months. The index recorded its monthly low on the final trading day of the month and put the month in the books with a -6.58% decline. The bulls swung and missed all month long…actually, they didn’t even get the bat off their shoulders. Participants got caught expecting one pitch, but Trump threw ‘em another. It’s apparent the S&P 500’s 17.51% climb the first four months of the year priced in expectations of a done deal on the trade front. Then Trump spent nearly every Sunday in May tweeting tweets that brought the validity of a done deal into question, and so market participants immediately began to “correct” their expectations about deal or no deal and the global economic implications. This manifested itself into a selloff for the S&P 500, and obviously participants are still in the process of discounting what lies ahead into the future.
So, where do things go from here? First, in my last post (click here to read) I wrote about the idea of “a trade down toward ~2,743 sooner rather than later and a trade up to ~3,503 later rather than sooner”. So, here we are. Thanos got the upper hand first. It’s not that out of character given the context of what transpired the first four months of 2019. We haven’t even retraced one half of the linear advance from 2,346.58 to 2,954.13. Naturally, I’d be surprised if June’s low doesn’t land somewhere between ~2,650 and ~2,722, the region at which the S&P 500 has taken one big step back after having taken two huge steps forward.
The sequence here is again the giant unknown - i.e., do we trade down towards the ~2,650-2,722 region in the front half of June, or the back half of June? Most would prefer we find some capitulation sooner rather than later, since the decline at this point has been rather orderly. For example, the Volatility Index (VIX) peaked on Thursday May 9th at 23.38 - the S&P 500 closed Thursday May 9th at 2,870.72, ~100 handles to the north. Puking it up in the short term will create immensely “oversold” conditions across multiple time frames, which may then imbalance the actions of participants to the buy side (eager buyers step in, eager shorts cover). Puking is never fun, but we almost always feel better after we puke, and the same is true in the world of markets. So, I’d like to see the S&P 500 puke over the front half of June (analogous to trading down between ~2,650-2,722) so we can hopefully feel better by the end of June (analogous to closing the month in positive territory).
Zooming out a bit, and thinking beyond June, there are a few month end studies I found interesting. First, the S&P 500 just recorded a two-month pattern of an all-time high monthly close immediately followed by a “Bearish Outside Reversal Month” (BORM). Behaviorally speaking, the collective actions of market participants in May left a clear and obvious “double top” on the charts, and eager selling pressure emerged exactly where it last emerged. It’s as if the ~2,940 price region is “too good to be true” in the eyes of participants relative to their collective expectations of what lies ahead into the future. Put simply, there’s no reason for a long-term investor to be overly excited about sustained upside until the S&P 500 can breakout and sustain above the ~2,940 price region. And if this two-month pattern is any guide, there’s a chance the S&P 500 won’t breakout and sustain above the ~2,940 price region.
This pattern is rare; it’s only occurred 15 prior times since 1950. What catches my eye is that while the S&P 500 has tended to behave positively over the forward 3 months, closing higher 80% of the time for average returns of ~4%, it’s also tended to behave negatively over the forward 12 months, closing 8 of the last 11 instances in negative territory with an average maximum drawdown over the forward 1 year of -14.71%.
We saw similar price action in the Russell 2000 (RUT) for the month of May. The RUT’s month of May was defined as a BORM that declined -4% or worse. We only have 10 prior instances of this occurring for the RUT since 1990, but the RUT’s average forward returns across all time frames measured are less than stellar.
May also brings the calendar into the unfavorable period, and the unfavorable period during pre-election years has presented big challenges of late. The price action following May of each of the last three pre-election years has been downright nasty. 2015 saw the S&P 500 trade up by just 1.21% from May’s close over the forward 12 months, and down by -14.11% from May’s close over the forward 12 months. 2011’s figures were 5.74% and -20.10%, and 2007 was 2.97% and-17.88%. In aggregate these figures record at -8.40% and 13.61%, which would set a forward 12-month range of ~2,520-3,126. That said, I’d be remiss in not pointing out that the nastier May behaved (i.e., the largest of May declines, and note 2019 is the worst May in any pre-election year since 1950) during the pre-election year, the better the S&P 500 behaved forward-looking. Trump’s seemingly mastered the idea of “sell the rumor and buy the news”, so maybe the rhetoric in May’s as bad as it’s going to get. Unlikely, but something to ponder.
Speaking of nasty Mays, it turns out a nasty May has been a reason to actually “buy the dip” over the months ahead. There are 10 prior months of May that declined -4% or worse, and the S&P 500’s forward 1-year returns have been higher 10 out of 10 times for average returns of 16.27%. The average maximum forward 1-year drawdown and drawup records at -7.21% and 19.74%, which would set a forward 12-month range of ~2,553-3,295. When imagining 2019 giving back virtually all of its calendar year advance, with the future including meaningfully easier global monetary policy and an actual done deal, I’d bet participants will buy ‘em like mad at and around the ~2,500-2,550 price region.
Finally, and I’ve written this before but long-term investors are generally rewarded by investing (in the most traditional sense of the word) during primary uptrends for the S&P 500, which i’ll refer to as “beta”. The big money is mostly made by being right and sitting tight when “beta’s” moving from the lower left to the upper right. While “alpha” is sexy, it’s “beta” who’s most responsible for driving the returns us mortal long-term investors achieve. I define a primary uptrend for “beta” as a sequence of higher highs, higher lows, and higher closes for the S&P 500 over any period of time, whether you’re dealing in minute charts or monthly charts. The issue at the moment is that a top is a top until it’s not, and a primary uptrend can’t reassert itself until we breakout and sustain to fresh new all-time highs for the S&P 500, or until the chart is once again moving from the lower left to the upper right. Therefore, the best I can say at the moment is that the S&P 500’s primary trend is neutral, or sideways, and it will remain that way until there’s sustained expansion beyond the ~2,954 price region. The worst I can say is that the malaise since 2018 is the market’s way of transitioning between a decade-old “bull market” and a newly established “bear market”, and the rally off December’s low was a sinister “bear market rally”. Until such time that a breakout occurs, I believe it’s prudent for long-term investors to proceed with caution. You don’t drive 75 miles per hour when it’s incredibly cloudy/foggy and the roads have poor visibility, so why would you invest aggressively when the price action of the S&P 500’s is completely and totally trendless, with poor visibility? When the S&P 500’s in neutral, it’s ok for your portfolio to be closer to neutral, so as long as you have rules governing when you’ll put your portfolio back in drive and slam on the gas. If you think you can just park your portfolio in neutral in the present, and plan to rebalance your portfolio back to a normalized asset allocation at some point into the future, without clear, concise rules governing the execution, you’ll probably never get the bat off your shoulder. And it’s best if your portfolio doesn’t pull a Carlos Beltran. So proceed with caution, prepare in the present to win by not losing too much into the future, but make sure you check your “bear market” convictions at the door, because this nasty May could give way to slamming on the gas pedal for a long ride to the north whenever we finally puke it all up.