Over the past couple of months we’ve given you a historically based playbook on how the US equity market would perform in Q1 after an abnormally large January return, as we experienced this year. Here’s our methodology and how it turned out:
- The S&P 500 rallied 7.9% this past January, which is one standard deviation above January’s average return of 1.2% since 1958 (first full year of data).
There have been eight other Januaries that have also returned +1 standard deviation above the average, or just 15% of the time. These years: 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%).
- During February of those eight years after a big January, the S&P was up +75% of the time and rose 1.4% on average. This year, the S&P was up 3.0% in February, more than double the average but in keeping with the pattern of an ongoing rally.
- During March of those years after a large return in January and follow through in February, the S&P was still higher 75% of the time with an average return of 1.5%. There’s still two more trading days in March, but so far the S&P is up 0.75% this month. That’s below the March average, but balances out the above average February return.
- The S&P 500 finished higher in Q1 during all eight years when January returned greater than one standard deviation above the average. The average Q1 return for those years was +12.1% compared to 11.9% this current quarter with just two trading days left. Essentially right in line.
Bottom line, so far so good for Q1, but what happens in Q2? We wrote a piece on this a month ago, so we’ll briefly review this data as well before moving on to what it means for the year. Here’s the data:
- During the eight years prior to 2019 when the S&P returned over one standard deviation above the average in January, the S&P gained an average of 2.2% in April and was positive in +60% of those years. The best return was +5.8% in 1997 and the low was -1.2% in 1987.
- In May of those years, the S&P increased an average of 1.9% and was positive 75% of the time. The best return was +5.9% in 1997 and the low was -5.2% in 1967.
- In June, the S&P was up an average of 2.1% and also positive 75% of the time. The high was +4.8% in 1987 and the low was -2.9% in 1961.
- As for Q2 as a whole, the S&P advanced 6.3% on average. It was only lower once out of those eight years in Q2 1961, down 65 basis points. The best performance was +16.9% in 1997.
We’ll have to monitor whether these S&P return trends continue to follow this playbook over the next three months, but here’s the outlook for the year based on this analysis:
- Every year except 1987 generated double digit total returns for the S&P in the eight years when the index returned over one standard deviation above the average (save 2019) during the first month of the year.
- Here are the total returns for each year: 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 those years was 26.6%. That’s more than double this year’s YTD return so far of 11.9%.
That said, if years with especially strong Januaries rally in the first half, does it account for all that year’s gains or does it continue to advance in the back half? To answer this question, we looked at the same eight years we’ve been analyzing to find when the S&P peaked for the year during each:
- The earliest month in which the S&P reached its highest level of the year was in mid-July during 1975. The next earliest was in late August 1987.
- The rest of the years peaked in the fourth quarter. The years in which the S&P reached its highest level in September included 1967 and 1976. The S&P topped out in early October during 1989, and peaked in December in 1961, 1985, and 1997.
Important point: the 8 years with abnormally strong January returns mostly occurred in mid-to-late cycle, similar to where we are now. This year’s first quarter performed in line with the other years’ average, and history says there should be further upside in Q2. It’s not until the back half of the year – mostly Q4 – where this data shows the S&P may hit its highs for the year. The peak so far in 2019 was 2,854.88 on March 21st. If that is the high for the year, it would be an anomaly compared to the others with exceptionally robust Januaries.
As for widespread concerns about an impending recession given the flattening of the yield curve of late, history says that is not necessarily a problem. Here are other instances when the yield curve looked like an issue during the years we’ve called out based on the spread between the 10-year Treasury and Federal Funds Rate (10-yr minus Fed Funds):
- 1985: A spread of 3.07 points in March went negative to minus 4.46 points in December. Total return that year: +31.2%
- 1989: Negative 0.49 in March and still minus 0.04 in December. Total Return: +31.5%
- 1997: Minus 0.15 in March and still negative 0.09 in December. Total Return: +33.1%
- Current spread: +0.03 points
The upshot: despite a flat/negative yield curve during those years, they returned above average double digit returns.
In sum, the past is not always prologue, but history tells a surprisingly positive story about US equities. We are somewhat more cautious than history says we should be, but the historical record tells a clear enough story that it merits your attention as well.