The most bullish six months of the year for stocks is winding to a close
The following is a reprint of the market commentary from the May 2018 edition of The Option Advisor, published on April 27. For more information, or to subscribe to The Option Advisor -- featuring 10 new option trades each month -- visit our online store.
You'll perhaps find it sobering to realize that we're currently at the tail end of what has been, historically, the stock market's most bullish six-month stretch of the year. Over the past 50 years, the November-April half has been positive for the S&P 500 Index (SPX) 76% of the time, yielding an average return of 6.47% and an average positive return of 10.83%.
By contrast, the May-October half is positive only 66% of the time, with an average return totaling 1.29%; plus, the average positive return is smaller and the average negative return larger than that of November-April.
As of this writing, with mere days left to go before the books are closed on April 2018, the S&P is up just over 2% from its Oct. 31 close at 2,575.26 -- on pace to significantly undershoot not just its average positive return, but also its overall average return, by a fairly wide margin.
The graph below, created by Schaeffer's Senior Quantitative Analyst Rocky White, paints an exceptionally clear picture -- not only as to how the current November-April performance (in black) compares to that period's average trajectory (in green), but also of the not-at-all symbiotic relationship between these two bullish and bearish halves of the calendar year. While the November-April half typically charts a fairly steady path higher, the S&P's May-October path (in red) is a lazy, bumpy chop ranging between the general zones of "breakeven" and "slightly higher."
Given that May-October seems to more or less "coast on the fumes" of the typical November-April rally, you could accurately describe the relationship between these two halves as "parasitic." But when the S&P is more or less limping into the month of May, how long until the momentum runs out altogether?
In the table below, White categorized the last five decades' worth of S&P returns into "brackets" to determine how the index typically fares during the May-October period based on its immediately preceding November-April performance. There's a solid sample size for each bracket, and the takeaways from this data set are instructive.
Going simply by average return, it looks like the "sweet spot" for the S&P 500 is a six-month return between 5% and 10% by the end of April. On 10 prior occasions where the November-April return has landed in this range, the index has gone on to average a 4.30% rise over the next six months, with an impressive 90% of those returns positive.
But while the average negative return for these results is the smallest by far (-1.59%), note also that the average positive return for this bracket is the smallest among the four. In other words, the May-October upside is steady and consistent (and far better than the overall average return of 1.29% for this period), but not necessarily staggering in its magnitude.
More momentum doesn't necessarily beget more momentum, though. In the 18 instances where the S&P gained upwards of 10% during the November-April half, the average return for May-October was 1.99% -- not too much better than a typical year. And only 67% of returns are positive in this bracket, nearly flat with the expected 66% for this time frame. Plus, the average positive May-October return after a blowout November-April is just 5.66%, compared to the "anytime" average positive return of 6.44%.
And when there's a relatively rare S&P loss registered over the November-April period, May-October goes on to follow suit. The average return is a loss of 2.45%, and the average negative return (-15.55%) is the largest by far of the four brackets. But what about when the S&P is neither "comfortably higher" nor "sharply higher" nor "surprisingly lower," but just -- as we are now -- "kinda higher" by the end of April?
First we'd note, per the table below, that when the index gains anywhere up to 5% during the November-April period, there's only a coin-flip chance that stocks will be positive during May-October. This is the lowest percentage of positive returns for all four scenarios analyzed in this study.
That said, the expected average return for the upcoming May-October stretch would be a slightly above-average 1.53%, with the average positive return weighing in at a best-in-class 10.31% (just shy of the average positive return for the November-April period, actually). Of course, this silver lining is immediately countered by the stat showing the average negative return -- which we're about 50% likely to experience -- is a drop of 7.26%, second only in magnitude to the losses registered in those years when not even November-April yields a gain.
So let's hope that none of us were looking to this particular study for evidence that the volatile S&P chop we've witnessed lately is on its last legs, as we seem destined for an upcoming (continued) stretch of rapid, unpredictable price swings. But from a scholarly angle, perhaps we can at least appreciate the tidiness with which S&P closing lows in February and early April were contained in the 2,581 area, just above "breakeven" with the Oct. 31 close -- neatly mimicking the kind of support we often see come into play around year-to-date and year-over-year breakeven levels.