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.