3 Observations on Q118 and Thinking Forward

Wednesday, April 11, 2018 |

  1. Volatility is back, finally. While roughly 10% down from its peak (so technically we are in a correction now), the S&P 500 is down only -2% YTD and up 11.50% over the past 12 months (a/o 03/31/18). Historically, the S&P 500 has finished positive in 29 of the last 38 years; however, the average intra-year drop is around 14% (Source: JP Morgan). As such, the recent market moves are nothing out of the ordinary and depending on your time frame not all that drastic.
  1. The overall price trend of the market has weakened, but by our metrics is not bearish yet. That said, historically there has been more volatility below the 200-day SMA (Source: Irrelevant Investor) than above it and we are oscillating above and below that. That, taken with the fact we are coming off the lowest volatility period in market history and crossing below the 200-day SMA we would expect the volatility to continue. How much longer and further do we have to go? If history is our guide, we have about 2-3 months on average before we bottom. The peak was at the end of January, so the end of April if we are average or longer if we aren’t. Additionally, the drawdown is typically around 15% (Source: Capital Advisors, Ltd.). Both of these estimates have the caveat we aren’t in a recession and

Source: Daily Shot

  1. In our view, recession risk remains very low. To the contrary, if anything, the economic landscape appears to be strengthening. Additionally, the forward rate of change in earnings expectations is getting stronger, as indicated by the blue lines in each of the charts below. That is to say, until the fundamental data weakens substantially it’s hard to see the current moves in the market being the start of a sustained bear market.

Source: Capital Advisors, Ltd.

Source: Earnings Scout

S&P 500 Index is an index of 500 of the largest exchange-traded stocks in the US from a broad range of industries whose collective performance mirrors the overall stock market.

Investors cannot invest directly in an index. Past performance is no guarantee of future results.

Earnings Score = proprietary calculation from Earnings Scout those indicates the rate of changes of forward EPS estimates.

Recession Indicator – Internal model run by Capital Advisors, Ltd. that aggregated 15 economic data points into a model to estimate the probability of a recession. Each data point is given equal weight and a normalized value so they can be put in an index as a percentage +/- 0%. The percentage value is then averaged over the past 3 readings to smooth the data. From there the index is divided into 2 parts: the Median and Diffusion value (% of values that are positive). Each part is then looked at from the variance away from a neutral value. The Median assumes a 0% mean and a 5% standard deviation. The Diffusion assumes a 50% mean and 25% standard deviation. A z-score is then taken for each part and averaged together to get the final reading.

A recession is a significant decline in activity across the economy, lasting longer than a few months. It is visible in industrial production, employment, real income and wholesale-retail trade. The technical indicator of a recession is two consecutive quarters of negative economic growth as measured by a country's gross domestic product (GDP).

The 200-day simple moving average (SMA) is considered a key indicator by traders and market analysts for determining the overall long-term trend. The price level in a market that coincides with the 200-day SMA is recognized as a major support when price is above the 200-day SMA or resistance when price is below the 200-day SMA level.

Volatility is a statistical measure of the dispersion of returns for a given security or market index. Volatility can either be measured by using the standard deviation or variance between returns from that same security or market index.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts or Lincoln Investment.