Down Q1 Rule: What Happens Next Part 2

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Down Q1 Rule: What Happens Next Part 2

It’s all but official: the S&P 500 will end March lower after a down January and February, which has only happened in 5 other years over the last +6 decades. Here’s a recap on why this is an important market signal before we expand on this topic:

  • The S&P has only fallen in January, then February and again in March in 8% of years since 1958 (first full year of data). It happened in 1973, 1974, 1977, 1982 and 2008.
  • During the 5 years when the S&P was down in January, February and March, the S&P finished the year lower in every year except one, or 80% of the time and mostly by double digits. The average return from the close on the last day of March to the end of the year was -9.8%.

  • On a total return basis, these years as a whole were also down 80% of the time or negative by an average of 12.7%: 1973 (-14.3%), 1974 (-25.9%), 1977 (-7.0%), 1982 (+20.4%) and 2008 (-36.6%).

The upshot: In the 5 years when the S&P declined during each month of Q1, four occurred in deep recessionary periods and were all down on a total return basis (1973, 1974, 1977 and 2008). The only year the index ended higher on a total return basis was 1982, but that was coming out of a recession, unlike the current economic cycle which is surely headed into recession. Also worth remembering: in 1982 the S&P was trading at 8x trailing normalized earnings versus 21x today and, of course, the Fed was cutting rates from 15% to 9% at the end of 1982.

Given how unusual it is for every month in Q1 to finish lower in a given year, what are the odds for a down fourth consecutive month in April? Here are the stats:

  • Out of the five years in which the S&P was lower in all 3 months of Q1, only two also saw a down S&P in April. They were in April 1973 and 1974.
  • The S&P was not up in a given month until July of 1973 and October of 1974. On the latter year, keep in mind President Nixon resigned in August 1974. Also important: the oil shock caused by the Saudi embargo in Q3 1973.

    Both years offer a reasonable tell on the direction of US equities in the months to come as they were periods of corporate earnings resets due to earnings shocks from the oil crisis.

Bottom line: this is why Q1 earnings season, which starts in April, will be important even though the actual reported numbers will be poor and guidance will be thin on the ground. As we’ve highlighted several times, the S&P 500 at 2500 indicates continued market confidence that normalized earnings (after the COVID-19 Crisis is over) are similar to the trailing decade’s $122/share.

Lastly, for a refresher on when all months in a single Q1 are down and updated for April, history says:

  • The S&P will most likely bottom in Q4 and finish the year lower from March 31st (down 9.8% on average). That’s also true in years where the S&P was down for the first four straight months, such as in 1973 and 1974.
  • The YTD return through April 1973 and 1974 was -9.4% and -7.4% respectively. This is to point out that in each year, you could not have bought the April low. For example, if you bought the close on the last day of April, you would be down 8.8% and 24.1% at the end of 1973 and 1974 respectively.
  • … But the S&P is usually up on a total return basis in the subsequent year (for years when the S&P is down January through March). The only year this did not work was in 1973, as the index fell in 1974 (which also had several down consecutive months through past the first half of the year).
  • Takeaway: 1973 and 1974 presented the biggest bear market until the dot com bubble burst and Financial Crisis hit. While the subsequent two years had large total annual returns to recoup losses, investors had to be patient through a difficult couple of years: 1975 (+37.0%) and 1976 (+23.8%).

In sum, the market does not have to echo the 1973/1974 experience as long as the US government and Federal Reserve respond adequately, but those years do frame the downside case if investors adjust their structural earnings expectations. History does not have to repeat, but it does shine a light on why April’s Q1 earnings reports will be an important milestone and not just a throwaway quarter.