Trader’s Narrative

We’re getting a distinct message from the sentiment data that this rally, whether a bear market or cyclical bull market (or the first leg of a secular bull market) has overstayed its welcome.

If you have bearish leanings, then you wouldn’t mind comparing this recent 6 month old rally to ones that we saw in the aftermath of the great bear market that followed the 1929 top:

Source: Chart of the Day

This rally is now longer than almost all counter-trend rallies during the 1929-1932 bear market. It is only comparable to the biggest one (November 1929) which lasted 155 days and lifted the Dow by ~50%.

If, on the other hand, you have bullish leanings, then you would appreciate that we are following fairly closely the script provided by the aftermath of previous bear markets. Next up would be a shallow retracement and then a rather protracted trading range (click to see graph in previous link).

As well, looking back at previous cyclical bull markets since the 1940’s, we again seem to be following a familiar script. The data to the left is courtesy of InvesTech Research dividing each cyclical bull market into two phases. It is normal for the first 5 months of a rally to be robust while the following months are more lethargic. In fact, on average the returns in the first 5 months have been double those of the next 5 months. Which would again imply that going forward, we can not expect similar returns.

Seasonality
Don’t forget, we are also about to step into September - a most notorious month for stock market returns. Mark Twain famously wrote:

October: This is one of the peculiarly dangerous months to speculate in stocks in. The other are July, January, September, April, November, May, March, June, December, August, and February.

He was close, as he should have singled out September as the most dangerous time to be long. From 1896 to 2008, the average return for September has been -1.2%, the very worst of months. As well, in the more recent market history (20 and 50 years) the negative performance drag of September has been even more pronounced. Moving on, after September, the next worst month is February (probably because of profit taking after the January effect). And the best month? December, of course.

To illustrate just how damaging September is, imagine for a moment that you had a rich ancestor way back in 1900 who, for some masochistic reason, decided to invest the princely sum of $1000 in the Dow Jones but only during the month of September (and go to cash the rest of the time). Here’s the value of your inheritance over time:

Source: Have a happy September. Or not.

Believe it or not, after more than 100 years of investment in the Dow, the original $1000 would be worth just $251 today. That’s a heart-stopping loss of -75% for over 100 years of one month investment. So obviously, doing the opposite would give you a leg up. But you may not believe just how much of an improvement you would squeeze out of just skipping one single month! Compared to a simple buy and hold strategy through thick and thin over the 100+ years, skipping September would give you 4 times the return!