Weekly Update

February 5, 2016 Update

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As goes January…

Stock investors bid good riddance to a miserable month of January, the worst beginning to a year in stock market history. Chart 1 below provides a visual history of stock market returns:

Chart 1: A negative beginning to 2016

A negative beginning to 2016

We often hear the saying ‘as January goes, so goes the year’. Does the data support this saying? A negative return in January leads to a negative annual return 54% of the time, so just a bit more than a coin flip.

Chart 2: Does a bad January lead to a bad year?

Does a bad January lead to a bad year?

A negative January does have a 60% chance of bleeding over into a negative February (given that we just experienced one of the 10 worst January performances on record). We note that February is usually quite a positive month for stocks.

Chart 2: The 10 worst Januarys often bode ill for February as well

The 10 worst Januarys often bode ill for February as well

Indeed just last year a January rather similar in tone to the one we just experienced led to a nice February rebound. Can we get a repeat performance this year?

For a much more detailed analysis of January 2016 performance, go to: What January Says About Stock Market Returns In 2016

What is a “follow-through”?

As trend investors, we are ever on the lookout for changes in market trend. Coming out of a correction or pullback phase, the market typically delivers a very strong one-day short-covering rally. A short-covering rally occurs when investors who have taken positions profiting from a falling market recognize that their bets are going against them and quickly exit their short positions. To exit a short position, the investor must BUY stock. This fuels a sharp rise in the market until the shorts have cleared out their positions. This short-covering creates dramatic one-day rallies along the lines of the recent 2% rise in the Nasdaq 100. Trend watchers then look for what’s called a “follow-through day.” This is a day where investors bring new money to the market believing that a new uptrend is beginning. This new money fuels another positive market day to build on the sharp short-covering rally day. Thus, the market follows through on its potential new rally. This follow-through day can be even more powerful if it occurs a few days after the short-covering rally day. That’s because it signals a more reliable change in investor mindset, rather than a continuation of the brief sugar-high of the short-covering rally. Thus, these follow-through days become significant market events for investors seeking a bottom and end to a market pullback or correction.

The same concept holds when the market is reaching a top. There are sharp one-day drops typically referred to as “profit-taking” days where investors bank some of their recent gains. The question then becomes whether they will go beyond banking profits to actually cut back their core position. To do that requires a change in outlook on the part of investors. So, we count days when the market takes a hit and keep score. If an abundance of these days piles up, we know that investors have collectively changed their mind and the trend is changing. We know that changes in trend start with sharp moves in price. We know that markets fall a whole lot faster than they rise. As a result, it’s never easy to identify the change in trend (except in hindsight!). But we keep trying and hope to be right more than we’re wrong. If so, we likely win the investing game, beat the market, and build our wealth in the process.

Market Update

Investors strolled into February with a couple of positive weeks behind them and hopes that a bigger rebound was afoot. Monday’s weak reports out of China kept things tight with a weak open migrating to a flat finish on the day as a -6% day in the oil pits failed to upset investors. However, another -5% decline in the commodity Tuesday got the bears’ attention delivering a fresh -1.9% blow to stocks as semis and biotech added to the woe. A poor reading on services fed into fears that a recession in the manufacturing sector would bleed over into services. The report pushed stocks sharply lower early in Wednesday’s session.
The losses were reversed however when a member of the Fed’s board talked down the U.S. dollar noting that financial conditions have become a bit weaker. The plunge in the dollar sent oil and commodity prices sharply higher pushing related stocks upward to leave stocks +0.5% on the volatile day. Weakness in the dollar persisted Thursday to keep a bid under industrial stocks who have suffered over the past year as the dollar as soared in value. Continued poor earnings generally weighed down the market though with ConocoPhillips (COP) cutting its dividend to keep the energy sector cautious. Stocks closed just a touch positive on the day. Friday brought the monthly jobs report. It showed weakness in hiring but strength in wages, a mix of data that investors found particularly unpleasant as the wage growth could give the Fed reason to hike rates. More notable in Friday’s trade was a bloodbath among high-beta tech stocks. With few exceptions tech got wrecked with all of last year’s heavy hitters – Amazon, Facebook, Netflix, and Alphabet/Google – down in the neighborhood of -5% on the day. The S&P 500 was damaged to the tune of -1.9% while the tech-heavy Nasdaq gave up over -3%.

Warm wishes and until next week.