Was Q2 Too Far, Too Fast?

Advertisement

Q2 2020 ended last week with 19.95% gains.

As our Strategic Trader editors, John Jagerson and Wade Hansen, note below, that is the best quarterly performance since 1998. It’s also the second-best quarterly return in 30 years.

But what now?

Given this huge run-up, is the market due for a pullback? Or worse, another major correction?

Below, we’ll see what history tells us.

You see, John and Wade are technical experts. This means they heavily rely on charts, numbers, and historical market studies to inform their market decisions today.

It turns out, when John and Wade ran the numbers, they found 16 other instances where the quarterly gains in the S&P 500 came in above 10%.

So, what happened in the market following those strong quarters? And what does that mean for us looking forward today?

In today’s Digest, you’ll find out.

Have a wonderful Fourth of July weekend,

Jeff Remsburg

 

Is the Market Overextended? History Says No

By John Jagerson and Wade Hansen

In this week’s update, we plan to check in on where the market has been so far in 2020, where we think it is likely to go and what historical evidence can be used to improve our strategic planning.

As we mentioned last week, there are plenty of signs that the market is still very fragile. That hasn’t changed, but to get a more balanced outlook, we want to examine the statistical and economic evidence in favor of stability and higher prices in the short term.

The second quarter of 2020 ended on Tuesday with the S&P 500 up another 1.54%. The total gains for the second quarter are now 19.95%. That is the best quarterly performance since the fourth quarter of 1998, in which the S&P 500 gained 20.87% and the second-best quarterly return over the last 30 years.

At this point, it is tempting to assume that since the index has had a big run-up, it will be “due” for a pullback and may not finish the next six months positive.

However, we ran the numbers, and of the 16 other instances where the quarterly gains in the S&P 500 were over 10%, we found that the market at large continued to rise in 13 of those instances for the next six months with an average gain of 9.02%. In one of the losing cases (the first half of 2000), the market only fell 1% over the next six months.

 

Daily Chart of the S&P 500 Since January — Chart Source: TradingView

 

So, although traders tend to look at the market and feel like it is “too high,” we have to temper that impulse with the historical data that suggests another decline is far from a sure thing. The six-month win rate following a big positive quarter is 81% while the random chance that any six-month period is positive in the market is just over 72%.

We don’t want to fall into a trap of assuming “this time is different” by ignoring the historical evidence and not taking advantage of bullish trends while they are available. However, we think any rational trader would agree that this time it is pretty different, so we still need to maintain a very cautious and flexible outlook.


Presidential Elections

The four-year election cycle is also something we have been getting a lot of questions about. Since 1950, the third year of any given presidential term tends to be the best, and the fourth and first are the worst. President Trump’s term seems to be tracking along with the long-term averages so far.

Our theory is that this phenomenon reflects traders discounting uncertainty just before and after the election and then removing that discount once they feel more confident about the President’s policies and likely future actions.

The political party of the incumbent or incoming president doesn’t make a big difference for market outcomes. Republican presidents tend to have the worst last year of a presidency while Democratic presidents tend to have the best returns overall, but it’s not by an overwhelming margin.

This year is different in the sense that investors are dealing with the unknowns of the election, the COVID-19 pandemic and extreme economic disruptions at the same time. This makes it harder to apply long-term averages to the market, but since the market is still down overall for the year, we don’t see any reason to automatically assume it is overextended — yet.


Technical Outlook

The S&P 500 has been consolidating since it hit its high on June 8. However, the two lows on June 15 and June 29 could form a “double bottom” continuation pattern if the index can break above 3,150.

As you can see in the following chart, a breakout would lead to a short-term target of 3,300 on the index, which could be an ideal point to start selling calls on some of our long stock positions. Despite the bullishness in the market, the premium income we can harvest at new short-term highs is worth the potential risk of being called out of those trades if the market rallies much more than expected.

 

Daily Chart of the S&P 500 Since April — Chart Source: TradingView

 

Although the price action on the major stock indexes has been very bullish lately, risk indicators are still signaling caution. Gold is at a new multiyear high, bond yields are at record lows, and volatility indexes are still well above average for a bull market.

This tells us that investors are still focused on diversification, which can lead to surprising whipsaws like the one on June 11, when the S&P 500 dropped nearly 6% in a single session.

 

Daily Chart of Gold and the CBOE 10 Year Treasury Note Yield Index (TNX) — Chart Source: TradingView


Economics

The market got a big boost this week from a huge month-over-month increase in pending home sales (+44.3%), and the Case-Shiller year-over-year home price index was up again this week (+4%).

Housing is usually a good bellwether for the employment outlook, so expectations are rising for Thursday’s unemployment and jobs report. We got a sneak peek at that jobs data this morning from ADP when it reported a gain of 2.37 million jobs in June, which was less than expected but still very positive.

However, the economic data we have now is lagging and is a reflection of attitudes and hiring nearly two weeks ago, before concerns about the new COVID-19 hotspots started to take hold.

While we don’t think this negates the positive (or “less bad”) economic trends, it does suggest that a focus on income over growth opportunities is the best strategy through the next few months.


The Bottom Line

As we mentioned last week, there are some signs out there that show the market is still in a fragile position. However, we have to temper some of our instinctual wariness by being clear-eyed about what is still going well or improving.

We are in uncharted territory as we wait to see how far the nascent recovery can go and whether hiring will drop off again. We see more than enough evidence to maintain a cautiously positive outlook for the summer, barring more negative surprises related to the pandemic.

The historical data still points to a higher than average probability of positive returns in the near future, and with the market still negative for the year, we aren’t as concerned about prices being overextended relative to the presidential cycle as we would be normally.

Our strategy will continue to be a focus on driving income from the strongest companies in a position to benefit from the changes in the economy.

Sincerely,

John Jagerson and Wade Hansen


Article printed from InvestorPlace Media, https://investorplace.com/2020/07/was-q2-too-far-too-fast/.

©2024 InvestorPlace Media, LLC