History Points To More Volatility Ahead

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History Points To More Volatility Ahead

Our historical playbook analysis of what happens after the S&P 500 has outsized gains in January has worked nearly every month this year. Abnormally strong January returns have been a historically clear signal about market direction over the balance of the year and we can now add August to the list. Here’s a recap of our analysis and how it has performed thus far in 2019:

  • The S&P 500 rose 7.9% during January this year, which is one standard deviation above this month’s average return of 1.2% since 1958 (first full year of data).

    There’s only been 8 other Januaries that have also returned +1 standard deviation above the average, or 15% of the time: 1961 (+6.3%), 1967 (+7.8%), 1975 (+12.3%), 1976 (+11.8%), 1985 (+7.4%), 1987 (+13.2%), 1989 (+7.1%), and 1997 (6.1%).
  • The S&P is on average higher most of the time every month from February through July after an especially robust January return. This year was no different, except for May when the S&P fell 6.6% due to trade concerns. It snapped back by 6.9% in June, however, and was also up 1.3% in July.
  • By contrast, the S&P has experienced negative returns most of the time in August during these special “Strong January” years, down an average of 50 basis points. That the S&P fell 1.8% last month was therefore no surprise to us, as we had been warning clients.

Overall, six out of seven months this year has worked in line with historical averages, including August as our “Strong January” playbook signaled it would be down. With that, here is what typically happens in the following months based on years with especially large January returns:

  • September (bad): The average historical return is negative 0.1% and the S&P was lower +60% of the time. The weakest return was -3.5% in 1985 and the strongest was +5.3% in 1997.
  • October (bad): The average historical return is negative 2.5% and the S&P was down +60% of the time; excluding the stock market crash in October 1987, however, it was up an average of 22 basis points. The lowest return was -21.8% in 1987 and the highest was +6.2% in 1975.
  • November (good): The average historical return is +1.3% and the S&P was higher 75% of the time. The worst return was -8.5% in 1987 and the best was +6.5% in 1985.
  • December (really good): The average historical return is +2.8% and the S&P was higher 88% of the time. The weakest return was -1.2% in 1975 and the strongest was +7.3% in 1987.

Bottom line: August’s US equity market instability will likely last through October. That makes sense in the context of our work on volatility; the VIX most commonly peaks for the year in August and October since it was created in 1990. Those two months usually see more market churn and, in this case, lower returns. While we remain cautious on US equities over the next two months, the S&P usually recovers those losses in November and December, and ends the year higher. Also not a coincidence, December is the quietest month of the year with the VIX having troughed 8 times during that month.

Despite higher volatility and lower returns from August through October, here’s how the S&P has performed overall during years with abnormally strong January returns:

  • Every “strong January” year except 1987 saw positive double digit annual total returns for the S&P: 1961 (+26.6%), 1967 (+23.8%), 1975 (+37.0%), 1976 (+23.8%), 1985 (+31.2%), 1987 (+5.8%), 1989 (+31.5%), 1997 (+33.1%).

    The average total return for these years is 26.6%. This year, the S&P is up 15.9% YTD.
  • The earliest month when the S&P reached its high for the year was in mid-July 1975, followed by late August in 1987. 

    The rest of years peaked in September or the fourth quarter. The S&P reached its highest level in September during 1967 and 1976. It also hit its high in early October during 1989, and peaked in December in 1961, 1985 and 1997.

As a final point, keep in mind that the eight years with abnormally strong January returns mostly occurred in mid-to-late cycle periods, similar to where we are now. We still expect the S&P to end the year higher likely by double digits. But the pathway will remain choppy over the next two months as investors negotiate future Fed action, expectations for corporate earnings and the ongoing US-China trade war.