Flat start does not mean a flat finish
Oct 07, 2015 12:21PM ● Published by Neighbors Magazines
The S&P 500 dipped into negative territory for the year last week (on Aug. 12) and is only up about 1% year to date.
The bond market has been flat—the Barclays Aggregate Bond Index has returned just 0.51% so far in 2015. Even the U.S. economy was relatively flat during the first half of 2015, with just 1.5% growth in gross domestic product (GDP) on an annualized basis, well below potential. Flat, flat, and more flat!
With the S&P 500 still fairly close to flat on the year (+1.6% on a price basis as of Aug. 14), we look at how likely stocks are to produce a solid year of gains. A look back at history over recent decades is encouraging.
What being flat in august means
The S&P 500 is about 1% higher than where it started the year, but it crossed under the flat line briefly in mid-August. The first question we tackle is how likely the S&P 500 is to produce a positive year when it moves less than 2% as of the start of August. We looked at data back to 1950 and found that if the S&P 500 is within 2% of where it started the year as of Aug. 1, it is more than 70% likely that the index ends the year higher. And in those years when it does end higher, the average gain is a solid 7.4% (excluding dividends).
A different way of looking at the data reveals an even more encouraging picture. There have been 30 years since 1950 in which the S&P 500 was flat or down as of Aug. 1. In 14 of those 30 years the S&P 500 ended the year higher.
An impressive feat, considering some of those years saw significant annual declines when August began. But the same analysis during a more recent period—going back to 1980, reveals an even more compelling story. During those 17 years in which the S&P 500 was flat or down, in only six of them did the S&P 500 end lower (eight were higher and three were flat). The average gain during those up years was 9.6%. It is also interesting to look at how late in the year the S&P 500 showed a year-to-date loss before producing these solid gains. Many of these solid years (1971, 1982, 1998, and 2004) were in the red for the year as late as October or even November and still produced solid high-single digit or even double-digit gains. This is the classic fourth quarter rally that we may see again this year.
So what might fuel another late year rally?
We continue to expect earnings to be a catalyst to push stocks higher over the balance of the year. Although on the surface the 1–2% year-over-year earnings growth figure for the S&P 500 in the second quarter is hardly impressive, earnings growth excluding the energy sector is very impressive (estimated at 9%). Also consider that figure includes several percentage points of drag from the strong U.S. dollar, which reduces overseas profits generated by U.S. multinationals. Better economic growth in the U.S., less drag from the energy sector and a strong dollar could potentially all contribute to improving earnings growth in the second half. The possibility that the Federal Reserve (Fed) surprises the market somehow is a risk, but the stock market has a history of effectively negotiating the start of Fed rate hike cycles. Slowing growth and the currency devaluation in China do not change our expectation that the Fed will hike rates before the end of 2015. A more pronounced slowdown in China, however, is a risk. We expect slower growth in China to be offset by potentially stronger growth from other overseas economies, including most of Europe and Japan, and to lead to slightly stronger global growth in 2015 than 2014.
This year has brought a whole lot of flat. But the S&P 500’s dip into negative territory should not be interpreted as a sign that a weak year for stocks is a guarantee. We see several potential catalysts for a late-year rally, most notably earnings.
Angelo Imbrogno is president of Blue Diamond Wealth Management, Inc.
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