History suggests now's the time to buy the S&P 500
A couple of weeks ago, I discussed some S&P 500 Index (SPX) overbought indicators. Looking at the chart, the steadiness of the uptrend since November jumped out at me, which then got me looking into some more numbers I found intriguing. The index is up over 20% over the last four months. Arguable more interesting, however is that the worst you could have done in buying and selling the index over that period was marginal 1.98% loss. That’s the max drawdown for the SPX over the past four months. I wondered if the steadiness of the uptrend was in fact remarkable, and if that steadiness gave us insight into what to expect moving forward.
S&P 500 Makes Big Moves Higher
First, I looked at how the S&P 500 performs going forward after it records a 20% gain over a four-month stretch. Since 1950, there were 21 other instances when the S&P 500 was up 20% over four months. Strength begets strength, considering tended to be strong going forward. The short term, two-week returns tended to underperform. But, amazingly, six months after these signals the S&P 500 was positive all 21 times, averaging a 9.2% return. Further, one year after these instances the index was up 90% of the time, averaging a gain of almost 15%. These returns easily beat the S&P 500's usual returns.
Next, I broke down those 21 instances of 20% returns by the maximum drawdown over the four-month period. For reference, the average drawdown was 7.2%, with a median of 5.7%. As I mentioned above, the current max drawdown is 1.98%. There was one signal that occurred in February of 1961, in which the max drawdown was less than the current figure (it was 1.86%). After that instance, the index continued its steady uptrend, gaining about 5% over the next three months, 7% over the next six months, and 10.5% over the next year.
Stocks tended to do well whether the drawdowns were large or small. The six-month returns were slightly better when drawdowns were small (average of 9.7% when small vs. 8.9% when larger). The one-year returns haven’t been as good, averaging 10.6% with 88% positive when drawdowns have been smalls vs. 17% and 92% otherwise. Either way, however, they beat the typical market returns.
A Close Look at 2% Max Drawdowns
A max drawdown of less than 2% over four months is an exceptionally rare occurrence for the S&P 500. There were just seven other instances of this going back to 1950. Those times are listed in the table below. Based on these numbers, it’s a sign of underlying strength in stocks. The S&P 500 was positive every single time over every single time frame listed below from two weeks to one year. The worst-case scenario over the next six months was a 6.3% return. If that’s the floor, count me in (obligatory reminder that historical performance may not be indicative of the future and it only covers seven data points, but it’s still comforting to have history on your side).
