Down Q1 Rule: What Happens Next

By admin_45 in Blog

With the S&P 500 down 19% so far in March and a still - uncertain outlook on containing the COVID-19 outbreak, it’s safe to say the index will likely be down again this month after ending lower in both January and February. Here’s a refresher on why this is an important market signal before we expand on this topic:

• The S&P has only fallen in January, then February and again in March in 8% of years since 1958 (first full year of data). It happened in 1973, 1974, 1977, 1982 and 2008.

• During the 5 years when the S&P was down in January, February and March, the S&P finished the year lower in every year except one, or 80% of the time and mostly by double digits. The average return from the close on the last day of March to the end of the year was -9.8%.
  
• On a total return basis, these years as a whole were also down 80% of the time or negative by an average of 12.7%: 1973 (-14.3%), 1974 (-25.9%), 1977 (-7.0%), 1982 (+20.4%) and 2008 (-36.6%).

Takeaway: In the 5 years when the S&P fell during each month of Q1, four occurred in deep recessionary periods and were all down on a total return basis: 1973, 1974, 1977, and 2008. The only year the index ended higher on a total return basis was 1982, but that was coming out of a recession, unlike the current economic cycle.

Given that the S&P will likely register this highly unusual 3-month consecutive decline at the start of the year for just the 6th time ever, here are two more key points to consider:

#1: This is when the S&P 500 bottomed during each of these unique 5 years:

• 1973: December 5th, 1973
• 1974: October 3rd, 1974
• 1977: November 2nd, 1977
• 1982: August 12th, 1982
• 2008: November 20th, 2008

Takeaway: in the 5 years when the S&P dropped during each month of Q1, the S&P did not bottom until the 4th quarter in 4 out of 5 years. Again, we note that these four years happened during recessionary periods. Even the one year that the US economy was coming out of recession the S&P did not bottom until August, or the middle of Q3.

#2: Given that we know the S&P 500 will likely hit this 3-month signal, here are the rest-of-year returns for an idea on what investors would miss out on by going to cash on the last day of March at the closing print:

• 1973 (closing price on last day of March to end of year): -12.5%
• 1974: -27.0%
• 1977: -3.4%
• 1982: +25.6%
• 2008: -31.7%
  
• Average: -9.8%

…And if you bought the closing print on the last day in December of these uncommon 5 years, here were the total returns for the next year:

• 1974: -25.9%
• 1975: +37.0%
• 1978: +6.5%
• 1983: +22.3%
• 2009: +25.9%
  
• Average: +13.2%

Takeaway: If after seeing this 3-month signal you sold your holdings in the S&P 500 at the closing print of the last day of March, you would have avoided rest-of-year losses in 4 out of 5 years. Even including the one up year, the average rest-of-year return was down almost 10%.

Further, if by listening to history (which points to a down year even after March), you stayed in cash and bought the closing print on the last day in December, you would most likely be higher on a total return basis over the next year. The only year it did not work was at the end of 1973, because the S&P was down in January, February and March during both 1973 and 1974. Excluding the false positive of 1973, the S&P was up an average of 23% on a total return basis in the year after the remaining 4 years in which every month in Q1 ended lower.

Bottom line: when the S&P 500 falls in January, February and March as it will most certainly do this year, history says that the index will likely bottom in Q4 and finish the year lower from March 31st. That said, the S&P is usually up on a total return basis in the subsequent year.

Consider this an adjunct to all our work on the “2008 Playbook”, which essentially argues that 2020 is a supercharged bear market caused by an existential crisis. The pain on the way down is very bad indeed, but bottoms do form and a year later stocks tend to do quite well.