Trader’s Narrative

Recently we looked at several technical reasons to expect the primary trend to continue to be up, while at the same time being mindful of a possible short term correction. One of those reasons was that the proprietary demand and supply gauges from Lowry Research (Buying Power and Selling Pressure) continue to paint a very robust picture with demand for stocks continue to rise to a new high for the cycle and supply continuing to shrink to new lows:

Source: Jon D. Markman

As well, there are two major cycles that offer us a wider context: the election or presidential cycle and the annual seasonality cycle, commonly known as “Sell in May and go away”. We looked at the presidential cycle recently. It suggests that historically, we are in the worst portion of that 4 year pattern. Similarly, annual seasonality is about to turn negative with the weakest months of the year coming up in a matter of days.

The worst month for stock market returns is not October as most would think but rather September. Statistically, it is a horrible month, both for the number of times that it has been negative and for the amount of money lost in the month. But as Wayne shared with us, if September can buck the trend and close positive, it is a very good omen for the stock market (When September Flexes Its Muscle).

According to Markman, a report from Lowry Research shows that the seasonality that starts in May is not reason enough to exit long positions. Since September is a consistently poor month for stocks, Lowry ignored that month and instead looked at the time period between May and the end of August. Since they work with the assumption that the stock market behaves differently under bull and bear market conditions, for each of those 4 month long periods, they looked at the Dow Jones Industrial index from 1950 onwards and separated each instance into either bull or bear markets.

Their conclusion is that if we are in a bull market, it is wiser to remain long stocks than to simply sell because of the calendar. Among the 39 bull market cycles considered, only 9 periods resulted in a loss between May and the end of August. The average gains (+4.7%) also handily beat the losses (-1.94%). Last year is a good example - the Dow rose 16.26% between May and the end of August. But as you’ll recall, it was only in August of last year that Lowry issued an intermediate buy signal and finally changed their mind regarding the primary trend.

Another reason you may want to rethink a change in posture is that being out of the market for August, September and October would also mean that you would be missing out on the best performing quarter for the presidential cycle. As well as the following 2 years which are the best for that pattern.

Not to sound like a broken record, but the only dark cloud on the horizon is option sentiment. Just today, even as the equity markets squeaked out barely on the positive side, option metrics from both the ISE and CBOE exchanges showed that traders continue to favor calls over puts by a 2 to 1 margin. The only other cautionary indicator is the Investors Intelligence sentiment survey which came in last week with 3 times as many bulls as bears, the sort of ratio we’ve seen at market tops).