Indicator of the Week: 3 Charts Flashing a Warning Signal for Stocks

The early part of the presidential cycle doesn't bode well for the SPX, historically speaking

Senior Quantitative Analyst
Jan 4, 2017 at 7:06 AM
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After a horrendous start to 2016, stocks soared higher during the year. The S&P 500 Index (SPX) gained nearly 25% from its February low. Also, since the week before a very interesting election in early November, the index is up over 7%. This week, I'll take a look at some 2016 stats, and review other years that were similar to 2016 to see how stocks did the following year. Finally, I'll take a look at how stocks have typically performed in the first year of a president's term. 

Up Days & Down Days: The yearly return for the SPX is a function of the number of up and down days, and the average return on those up and down days. Below, I show the data for each year since 2000. I think most investors would agree that the 9.54% return in 2016 was satisfactory, especially after that terrible start to the year. The 2016 return was pretty good vs. the average return in the table, 4.11%, but ranks near the middle of the pack as the eighth best return out of the 17 years. It looks like most of the credit for the index's return is its low average negative day, which ranked third best in the table. This led to a pretty high ratio of the magnitude of the positive day to negative day. The ratio in 2016 ranks fourth in the table below:

spx since 2000 jan 3

Years Like 2016: The chart below shows the years with the most similar path compared to 2016. The most similar was just a couple years earlier in 2014. There, too, you see the index fall in the first part of the year and then recover, and then ultimately end up closing not too far from the 10% annual level. 

spx similar years jan 3

If these years are similar to 2016, could it be an indicator for 2017? Based on the table below, let's hope not. After each of these five years that are most like 2016 (at least by my method), the next year has been negative in every single instance. The average loss was 4.6%, ranging from a loss of 0.73% to a loss of over 11%.  

spx next year returns jan 3

Presidential Cycle Returns: The table below looks at SPX data since 1949, or 17 full presidential cycles. The extreme outperformance in the third year of the cycle is widely known. The other three years in the cycle all average a return of between 6% and 7%. The first two years of the cycle have been the most volatile, as measured by the standard deviation -- and have a percent positive below 60% -- while the third and fourth years of the cycle have been positive over 80% of the time. 

spx presidential cycle returns jan 3

The table below breaks down the cycle years by the first half and second half. The first half of the first year has shown pretty poor performance. The S&P 500 averages a gain of 1.54% and has been positive less than half the time. One theory for the underperformance is that legislators might push their most market-damaging ideas as early as possible, so they are forgotten by the next election. Based on this analysis, and how stocks tend to do in years after those similar to 2016, it could be a tough go in the first part of 2017.

spx presidential cycle returns summary jan 3

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