I’m a big believer in playing probabilities. We’ve had a stock market moonshot in the first 10 months of 2013, with the benchmark S&P 500 index up 23.2% through October 31. How does the market perform in the last two months of the year when you’ve had a brisk rally in the front part?
The folks at Avondale Asset Management looked back and uncovered some interesting facts. Since 1957, when the S&P 500 took its present form (500 stocks), there have been 24 years when the index climbed more than 10% in the first 10 months.
In 21 of those 24 years, the market went on to gain further ground—an average of 4.5% in the final two months. What’s more, of the three losses, the worst was only 0.7%. For the complete record, click here.
So the odds strongly favor an extension to this year’s monster rally, at least through year-end. An “average” year-end bounce, per the Avondale figures, would take the S&P to 1835. For the past several months, as you know, I’ve been predicting a move to 1800 or slightly higher by late December.
All well and good.
Yet I don’t think this is a time for complacency. While the headline indexes may well be able to churn a bit higher through year-end, problems are building beneath the market’s placid surface.
I’ve talked extensively about the issue of high valuations, so I won’t labor that point just now. I’m more worried at the subtle breakdown we’re witnessing in market breadth.
Fewer and fewer stocks are driving the indexes forward. To see what I mean, take a glance at this chart, which plots the number of S&P 500 stocks trading above their own 200-day average price.
This gauge peaked back in May, at the S&P’s first significant high of the year. Since then, fewer and fewer S&P stocks have taken part in the market’s run-ups (red downtrend line on the chart).
Equally bothersome, the indicator has made three successive lower lows (see red arrow for the last low in early October). This is a classic pattern as the market approaches an important top. Fewer and fewer merrymakers come along for the ride up, and more and more take the roller-coaster down.
Bottom line: There’s trouble brewing. It may not manifest itself in a serious way until after the turn of the year, perhaps not until even March or April. However, you don’t want to be taking on additional risk at this stage in the cycle. If anything, you should be dialing back your market risk.
How? First of all, by doing some judicious selling. Go over your holdings, and check how they performed during the 2007-09 bear market. If they fell by a greater percentage than the S&P 500, consider selling, preferably before the end of 2013.
On the buy side, the market’s run-up since October 8 has narrowed our shopping list, but not quite extinguished it. I’m still bullish on ConAgra (CAG), especially now that the food processor has affirmed its earnings guidance for FY14 (ends May 31).
In January 2013, CAG completed its takeover of Ralcorp, the nation’s largest producer of private-label foods (store brands). Over the next few years, as ConAgra integrates the acquisition and squeezes out costs, I expect the Ralcorp deal to help accelerate the parent company’s earnings growth to the 8%-10% annual range (excellent for a “staples” producer). Meanwhile, you’re pulling down a safe 3.1% dividend.