Do Markets Top on Good News?

It's a good thing that Macro Man still has a full head of hair, because with the amount he's been scratching it recently he'd have some awful marks without it.  Equities have once again nudged close to the highs of the year, the level where they've failed time and time again in 2014.     For most of the last few months, Macro Man's taken it almost as an article of faith that stocks would roll over come May, both because of the poor historical performance and the persistently weak seasonality in recent years.

In that vein, he's taken some length off the table, because there's no point having a well-thought out plan if you aren't going to stick to it.   By the same token, however, it behooves him to stress-test the view periodically; it's still a bit cold and windy to be a lazy sunbather.

How bad is the seasonality in May, actually?   Does it depend on the prior four months of the year?  First, to get a sense of perspective, Macro Man checked the performance of the SPX in every month since 1980.  He was surprised to see that the average return is actually pretty solid: +0.93%.   What's also interesting is that pockets of weakness in May tend to cluster, as can be seen in '81-'84, '98-'02, and of course 2010-12.   Frankly, he is a little embarrassed to admit that he forgot that the SPX actually rallied in May of last year, so swept up was he in Tapergeddon and its impact upon the Japan trade.  Anyhow, last year's 2% rally in May was atypically large to be in a middle of one of these clusters.




What if we go further back?  Macro Man parsed data going back to 1929.  Unsurprisingly, the well-known historical pattern emerges, with the average return for the month coming in at -0.06%.   How much of this was down to bear-market performance, however?   Macro Man created a simple study to test.

Using both the full dataset since 1929, as well as the "modern" dataset since 1980, Macro Man tested to see what May's performance was like depending on the first four months' returns.  Specifically, he checked the average return in May when the index ended April down on the year, the average return when it was up more than 5%, and the average return for everything in between.  The results are summarized in the table below.


As you can see, when the index is modestly up on the year through April, May has historically been a very strong month.  Indeed, the 1.88% return since 1980 is higher than the average full-sample return for any individual month, even December.   As of Thursday's close, the SPX is up 1.64% year to date.   Hmmmmm.......

All of thiscertainly merits a pause for thought.  However, Macro Man cannot get the favourite saying of one of his mates out of his head: "markets top on good news."  To be honest, he hasn't studied this in any great depth, so he doesn't actually know if it's true.   It certainly sounds like one of those aphorisms that ought to be true, even if it isn't.

Regardless, the news has certainly been fairly decent recently, on both the macro side (a solid durables report) and the micro side (some of those earnings look great, and golly, Apple's gonna split!)  Moreover, the ECB looks like it has pushed all of its chips to the centre of the table (using another tired poker anaolgy),  as the recent rhetoric on both rates and the currency have been deafening.  Next Wednesday's CPI is not to be missed, and with excess liquidity breaking below the magic 100 bio barrier, if the ECB is going to act, it should come next month.


Of course, a cynic might suggest that absent a QE program for which there is currently insufficient infrastructure, a refi/depo rate cut will be the last throw of the dice, the bluff that the market will call.  (Yet another card analogy!)  Moreover, it is not altogether clear to Macro Man that charging banks for holding cash, thereby cutting into their NIM, is an unalloyed positive.   He could therefore have some sympathy that that "good news" could be sold.

At the same time, next week's US payroll figure also looms large.   If we ever do get a bang-up employment print, Janet Yellen will no doubt throw a party (to which she'd wear a polka-dot dress?)  to celebrate the good news.  Fixed income markets, on the other hand, might throw a public execution of the front end and belly.   5s-30s already looks like flattening inexorably...how long before 2s-10s follow?   And how will equities react?   "Not well" would appear to be a sensible guess.


As such, Macro Man finds himself in sympathy with his friend's aphorism, whether it be spurious or no.  His gut tells him that a top is close and that good news will in fact be bad news...potentially very much so.   His head, on the other hand, tells him that the boogie man in the seasonality closet may not actually exist.

In the end, he is left with higher conviction....that he doesn't currently possess an edge.  As such, he will stick to the process, follow the plan, and retreat further to the sidelines, awaiting further clarity one way or another.  When it comes, in whichever direction.....well, that really will be good news.
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Anonymous
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April 25, 2014 at 10:01 AM ×

C says
Pretty much what has been on my mind.
Regarding tops and good news. I read a book some years ago by Russell Napier that was quite a good take on the issue. In essence ,there is no real doubt that the two go together ,and logically of course by the time good news really is blanket coverage then more or less everybody is in as far as they can go. That of course leads to the completely unbalanced market situation. Trouble is there is still a certain amount of subjectiveness as to what the 'good news' level is. My back of the neck test actually doesn't read completely convinced at the moment. Certainly not to the level of prior major tops. Yet some issues such as margin levels etc suggest we are close enough for major caution. On that score I reiterate major tops typically go sideways for irritatingly long periods and thus my continuing stance is one of patience.

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Anonymous
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April 25, 2014 at 2:31 PM ×

I will dust off my spreadsheet but also interesting testing for the full sentence ie "...return on st leger's day". Appears returns from September to May are significantly higher than May to September, especially if the Sep-May period has been strong... cheers

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Macro Man
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April 25, 2014 at 2:56 PM ×

Oh, in broad strokes the seasonality is still very strong, in terms of weak performance over the summer. What I was getting at was this notion that one should vacate equity length by the beginning of May, which has been by planned modus operandi for a few months now.

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Anonymous
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April 25, 2014 at 4:06 PM ×

What are the potential triggers?

China? Russia? Scotland? GOP takes both senate and house?

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Leftback
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April 25, 2014 at 4:55 PM ×

Yes. The trigger will in fact be Good News, not bad, after all we have had an absolute wheelbarrow full of Ukraine, China and so on for months and the market has done absolutely nothing. Markets do peak on good news, and in part it is because of the interaction between Good News and the Yield Curve.

Sooner or later we are going to get a one-off "Bounce Back" in the employment number, the media will proclaim Morning in America, the Fed will then declare victory and take the QE ball home, (which they already said they were going to do anyway), and markets will start pricing in rate hikes by briskly eviscerating the front end. For those lazy sunbathers parked in the 2y, we salute your stoicism.

Equities, USDJPY, US2YR and US10YR will all scream skywards in unison, if only for 24-48 hours, and then we will see a grinding reversal for most of the summer as the usual flaccid US economic data makes a return, driven by the usual weak aggregate demand, but with Dame Janet sitting on her hands there will be no QE to rescue Mr Momo and his fabulous Pink Flamingoes.

The always instructive Treasury market is sending a few messages, already 5s30s is clearly in the process of flattening, which is not in fact a harbinger of US escape velocity, but a reflection of the strong gravitational pull of the Deflationary Black Hole that continues to plague developed economies.

So for now, we'd say prepare for a miniature rate spike of 10-15 bps, hedge fixed income exposure in the short term and then get ready to sell US and European equities and receive rates, while seeking bargains in emerging markets. What do you reckon, MM?

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abee crombie
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April 25, 2014 at 5:32 PM ×

LB, I think the pull back in EM will be shallow, there is quite a bit of strength there, not sure why but perhaps the sellers have been exhausted.

The rotation out of growth continues but will offer up some interesting corpses at some point. Yes AMZN, CRM etc are over priced but that does not change the fact that CSCO, MSFT, WMT are dinosaurs and business trends are not in their favour. Value investors beware. Dont ride those trains too long, but I suspect we are still in the early innings for them. I give it another 5 months of out performance in 'cheap old tech'

Two things have caught my attention recently, the drop off in housing (is it just weather?) and a possible spike in Avg Hourly Earnings.

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Anonymous
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April 25, 2014 at 8:25 PM ×

but its important to note that in the last cycles the flattening of the curve was also followed by strong stocks. Maybe this time will be different because we've had the QE.

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Josh O'Byrne
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April 25, 2014 at 9:06 PM × This comment has been removed by the author.
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Leftback
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April 25, 2014 at 10:07 PM ×

Anon @ 8:25, I think it is now clear that ZIRP/QE economies do tend to behave differently than their less centrally regulated textbook analogues.....

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Polemic
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April 25, 2014 at 11:44 PM ×

i agree woth josh.. though he deleated it.. but i saw it

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Macro Man
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April 26, 2014 at 12:37 AM ×

Pol, man, that cuts to the quick. I think Josh saw an early version of the new template as it was being formatted...hence the subsequent deletion (hopefully.) Lets give it some time and see how we like it.

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Anonymous
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April 26, 2014 at 1:40 AM ×

I like the new layout, myself.

Whammer

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Nico G
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April 27, 2014 at 11:08 PM ×

yield curve indeed... i vividly remembered March 2000 and its inverted yield curve which had really good (long) punters worried - kaboom

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Anonymous
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April 28, 2014 at 6:20 AM ×

Thanks Macro Man for your comment about Scottish Independence last week. You're right there may be Sterling storms ahead. Spent the weekend north of the border and the polls are much tighter than our highly paid London consultants had us believe. North East and Edinburgh generally against the split but the disindustrialised west, where the bulk of the population live, clearly pro independence. As one Tory MSP said to me 'third generation unemployed - they've got no hope so they believe it when Salmond tells them things can only get better'. Pollsters now talking up the Yes side to high 40's with the possibility of a Yes vote getting close to even.
It's exactly the same psychology as UKIP - if it wasn't for the EU everything would be great. Substitute English for the EU and you've got the Scottish story in a nutshell. Sterling strength story may be overplayed here.

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