The Dow Jones Industrial Average (DJI) on Tuesday suffered its fifth straight loss, weighed down by poorly received blue-chip earnings and broad concerns about bond yields. It was the Dow's longest losing streak since March 2017, when the index suffered eight consecutive down days. However, if past is prologue, this recent dip could present a buying opportunity for the DJI.

Below are the longest Dow losing streaks since 2010, courtesy of Schaeffer's Senior Quantitative Analyst Rocky White. The March 2017 retreat was actually tied for the longest during that time frame, matching a streak from August 2011. As for the severity of the decline, the March pullback closely resembles the November 2016 pre-election stretch. You'll notice that the DJI was comfortably higher both one and three months after those streaks. At last check, the index was headed for a sixth straight loss.

Honing in on the Dow's performance after just five-day losing streaks, we find the index tends to outperform. One week later, the DJI was up 0.73%, on average -- more than four times its average anytime one-week gain of 0.17%, looking at data since 2010. The Dow's average two-week gain after a five-day losing streak is 0.71% -- almost twice the norm.

Further, one month after a five-day losing streak, the Dow was up 2.3%, on average, and higher 80% of the time. That's compared to an average anytime one-month return of just 0.87%, with a win rate under 67%. Three months later, the index was up 4.88%, on average, and higher 84% of the time, compared to an average anytime gain of 2.8% with a win rate of 73.5%.

 

Micron Technology, Inc. (NASDAQ:MU) is trading higher today, up 5.2% at $50.09, catching a halo lift amid well-received earnings from chip sector peer Advanced Micro Devices (AMD). Prior to today's burst, Micron stock was mired in a steep pullback from its mid-March high at $63.42. If past is precedent, though, it could be time to bet on MU's next leg higher, as the stock is rallying from the site of a historically bullish trendline.

Specifically, the shares recently pulled back to within one standard deviation of their 160-day moving average. According to Schaeffer's Senior Quantitative Analyst Rocky White, after the previous two times MU stock pulled back to this moving average amid a broader uptrend, it averaged an impressive 21-day gain of 27.06%, and was higher both times.

A rally of similar magnitude would put Micron stock just north of that aforementioned March peak, which represented an 18-year high. MU has already added 21% year-to-date, and has outperformed the broader S&P 500 Index (SPX) by 22 percentage points during the past three months. 

Although calls are still preferred on an absolute basis, put buying has picked up in recent weeks. Data from the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) shows MU with a 10-day put/call volume ratio of 0.48, which ranks in the 99th percentile of its annual range. This means traders have been buying to open puts at a faster-than-usual pace relative to calls during the past two weeks.

Echoing this, Micron's Schaeffer's put/call open interest ratio (SOIR) of 0.72 also ranks in the 99th percentile of its annual range, suggesting near-term traders have rarely been more put-biased in the past year. An unwinding of pessimism in the options pits could add fuel to the stock's fire.

Digging deeper, the May 50 put is home to peak open interest. According to data from the major options exchanges, there has been a mixture of buy-to-open and sell-to-open activity at this strike in recent weeks -- suggesting traders are split as to whether MU will manage to hold its own above $50 over the short term.

Biotech name Heron Therapeutics Inc (NASDAQ:HRTX) once again appeared on Schaeffer's Senior Quantitative Analyst Rocky White's list of stocks that are currently trading near a 52-week high, but also sport a low Schaeffer's Volatility Index (SVI). This combination of stellar price action and relatively inexpensive short-term options could be signaling more tailwinds ahead for the surging drug stock.

Although absolute volume is low, calls are universally popular for HRTX, which sports a 10-day call/put volume ratio of 9.11 at the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX). This reading shows that calls have outnumbered puts by a nearly 9-to-1 ratio in the past two weeks.

Furthermore, Heron Therapeutics stock currently sports an SVI of 57%, ranking in the 14th percentile of its annual range. This low reading suggests that near-term options are pricing in relatively low volatility expectations at the moment.

Since 2008, there have been just two other times HRTX stock was flirting with a new high and had an SVI in the bottom 20% of its annual range. After those instances, the shares went on to gain 9.5%, on average, over the next month. A similar pop from current levels would place the equity back above near multi-year highs.

Looking closer, HRTX shares have rapidly climbed since mid-December, with pullbacks contained by their 60-day moving average. The stock, which has doubled in the past year, touched a three-year high of $32.70 on March 19, but was last seen trading 0.5% lower at $30.50.

Despite this positive price action lately, short sellers have been flocking to the drug stock. Short interest increased by 19% in the two most recent reporting periods to 9.36 million shares, the highest point since early December. This represents more than 21% of HRTX's total available float, and nearly seven days of pent-up buying demand, at the security's average daily trading volume. Should HRTX keep climbing, a short squeeze could be in play. 

Fast-food titan McDonald's Corporation (NYSE:MCD) is slated to report earnings before the opening bell on Monday. While the shares of the blue chip have struggled in 2018, the stock could be sending up a "buy" signal before earnings, if recent history is any indicator.

McDonald's stock recently pulled back to within one standard deviation of its 320-day moving average, after a lengthy stretch above this trendline. After the previous four pullbacks to this trendline, MCD stock went on to average a one-month gain of nearly 6%, according to Schaeffer's Senior Quantitative Analyst Rocky White.

At last check, MCD shares were slightly lower, down 0.1% at $158.72. The equity has given up 7.6% in 2018, but has found support in the $155-$156 area. Another 6% pop after earnings next week would place the Dow stock around $168.24 -- territory not charted since before the early February stock market correction.

McDonald's stock has moved higher after three of the last four earnings reports, gaining 5.6% the day after its earnings release a year ago. On average, MCD shares have moved 2.4% the day after the company's last eight earnings reports, regardless of direction. This time around, the options market is pricing in a slightly bigger-than-usual move of 3.7%, per at-the-money implied volatility data.

As far as direction, though, it looks like the MCD crowd is betting bearishly. On the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), the blue chip has racked up a 10-day put/call volume ratio of 1.50 -- in the 95th percentile of its annual range. In other words, options buyers have been initiating bearish bets over bullish at a much faster-than-usual clip during the past two weeks. Should McDonald's report strong earnings next week, a mass exodus of option bears could propel MCD higher.

 

IT services and consulting name Akamai Technologies, Inc. (NASDAQ:AKAM) will continue the theme of tech earnings next week, and is slated to release its first-quarter report Monday evening. AKAM stock has gained 52% over the past nine months, and enjoyed an impressive bull gap in mid-December, after hedge fund Elliot Management reported a 6.5% stake in the company, calling AKAM stock "significantly undervalued." Subsequent pullbacks in the shares have been contained by their 50-day moving average.

Looking at its earnings history, AKAM stock has finished higher the day after reporting in the past two quarters, including a 4% jump following its October report. The stock's average post-earnings daily price move is healthy 9.7%, regardless of direction, looking back two years. This time around, the options market is pricing in a slightly lower-than-usual 9.4% next-day move in either direction, per at-the-money implied volatility data. At last check, AKAM stock was fractionally lower at $71.37. A 9.4% move to the upside would put the shares around $78.07 -- within a chip-shot of March's two-year high.

Ahead of earnings, options traders have been leaning bullishly towards the tech name. Data from the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) shows AKAM with a 50-day call/put volume ratio of 4.68, ranking in the 98th percentile of its annual range. While absolute volume runs light, this suggests calls have been purchased over puts at a much faster-than-usual clip over the past 10 weeks.

Akamai Technologies has handily rewarded premium buyers over the past year. The tech stock currently sports a Schaeffer's Volatility Scorecard (SVS) of 89 out of 100. This means the equity has tended to register bigger price swings than its options premiums have priced in over the past 12 months.

"...something that has grabbed my attention when listening to a long line of guests on financial television during the past few weeks is the near-consensus opinion that earnings will drag stocks out of their recent funk... as a contrarian, I am reluctant to buy into the consensus here. Friday's poor earnings reactions out of the bank sector may be enough to convince you not to buy into this consensus thinking, either."
-- Monday Morning Outlook, April 16, 2018

"The long-awaited surge in corporate earnings and broad economic growth, which for many years seemed to be a distant hope, now appears to have arrived... And the surge comes at a time when investors are parsing a wide variety of fears, from geopolitical concerns to rising inflation. On Tuesday, that unnerved stock investors, who are finding that strong earnings increasingly aren't enough to push stocks higher."
-- The Wall Street Journal, April 25, 2018

Last week was the start of earnings season kicking into high gear, with multiple companies across a variety of industries reporting earnings -- quite a few of which were spectacular, as many stock market participants expected. "As many stock market participants expected" is the operative phrase in the prior sentence, as the market remains in neutral even as earnings reports and earnings beats charge ahead.

If you are trading with a one- or two-day holding period, last week's action might have been appealing. There were 11.65 points of movement from the April 20 close to Wednesday's intraday low to Friday's closing price that yielded a net gain of 0.19 point on the SPDR S&P 500 ETF Trust (SPY - 266.56). Another group that was happy with last week's action is index and equity exchange-traded fund (ETF) option premium sellers, given that the Cboe Volatility Index (VIX - 15.41) declined as the SPY, iShares Russell 2000 ETF (IWM - 154.69), and PowerShares QQQ Trust (QQQ - 162.09) were flat for the week.

There has been earnings-inspired directional movement among individual equities. But for every Netflix (NFLX), Visa (V), Facebook (FB), Boeing (BA), or United Continental (UAL) that responded considerably well to earnings, there has been an Alphabet (GOOGL), JPMorgan Chase (JPM), eBay (EBAY), Caterpillar (CAT), and Teradyne (TER), whose shares were knocked down significantly after their respective reports. As it stands now, with a full slate of earnings still due in the next couple of weeks, earnings have not provided the impetus that some bulls were looking for as the catalyst to move equities out of their doldrums.

A week ago in this space, I discussed in detail the technical backdrop of key equity indexes and ETFs. A support level I discussed came into play early last week on a sell-off that shook some investors, as the SPY 200-day moving average marked the lows once again. In fact, bulls and bears on Wall Street continue to wage battle, even as North Korean and South Korean leaders announced in a summit last week their plans to end war. Please refer to that April 23 commentary for key levels to focus on in the days and weeks ahead.

Geopolitical uncertainties are still present, such as the possibility of Trump pulling out of the Iran nuclear deal and full nuclear disarmament in North Korea a lingering question. Investors are also focused on the threat of trade tariffs and NAFTA negotiations, in addition to uncertainty regarding the Fed's pace of rate hikes.

In fact, another Federal Open Market Committee (FOMC) policy meeting is scheduled for this Wednesday. There is a glimmer of hope for bulls with respect to this meeting, if the 93% probability that fed funds futures traders are placing on the Fed to hold rates steady proves correct. As I displayed for you last week and again below, during the current tightening cycle that began in December 2015, the SPY has behaved much better in the short term in the immediate aftermath of the Fed holding rates steady relative to hiking rates.

"Call it the running of the bears. With equities almost three months removed from the last record, Americans have grown less optimistic that the market will bounce back. For the first time since Donald Trump’s shock election in November 2016, a majority of consumers expect stocks to be lower 12 months from now, according to the latest sentiment reading from the Conference Board. "
-- Bloomberg, April 24, 2018

"Investors are dumping U.S. stock funds at one of the fastest paces in a decade as rising market turbulence erodes confidence in the nine-year-old bull market. U.S. equity mutual funds and exchange-traded funds recorded $2.4 billion in outflows for the week ended April 18, according to the Investment Company Institute. That followed $41 billion in outflows from these funds in February -- the biggest monthly exodus since January 2008, ICI data show. Overall, investors have yanked $67 billion out of these stock funds since the start of February."
-- The Wall Street Journal, April 26, 2018

The triangle pattern that the SPY is in tends to be a continuation pattern in technical analysis -- implying the next move would be to the upside, since this is the longer-term direction of the equities during the last few years. However, I ran across yet another sentiment statistic last week on Bloomberg that suggested retail investors do not believe the next major move will be higher, per the factoid above. This builds on other similarities in the sentiment landscape relative to November 2016 that I shared with you last week. The negative sentiment expressed in that Conference Board survey is playing out in U.S. stock fund outflows since the February lows.

As such, the sentiment backdrop supports higher stock prices. However, if this year's lows are taken out, it becomes a matter of price action supporting the sentiment backdrop, therefore downgrading the significance of negative sentiment being a supportive factor for equities.

Continue reading:

• Indicator of the Week: 3 Must-See Charts on Stock Market Breadth
• The Week Ahead: Huge Trading Week Features Fed Meeting, Jobs Data, and Apple Earnings

Autodesk, Inc. (NASDAQ:ADSK) has made some big moves on the charts in recent months, both to the upside and the downside. The shares were last seen trading near $127, a roughly 10% retreat from their March 13 record high of $141.26. However, the software stock recently bounced from a noteworthy technical level, suggesting it could be poised for a short-term move to the upside.

Specifically, ADSK last week bottomed near the $121 mark. This region is home to an early March bull gap, and it contained a pullback in early April, as well. Not to mention, it represents a 50% Fibonacci retracement of the stock's rally from its year-to-date low to its year-to-date high.

But maybe most importantly, the 80-day moving average is currently docked at $121.80. This trendline has been an excellent "buy" signal in recent years, according to data from Schaeffer's Senior Quantitative Analyst Rocky White. Following the last six pullbacks to this moving average, Autodesk has averaged a 21-day gain of 7.98%, and has been higher after each occurrence. A similar move this time around would put the equity just above the $137 level.

Still, sentiment is mixed on the stock, despite its nearly 22% year-to-date advance. On the one hand, 15 of the 19 analysts in coverage say to buy the shares, and the average 12-month price target stands up at $148.25. But short interest keeps rising, up 34.1% in the last two reporting periods, and the 7 million shares now sold short is the most in almost a year.

Also, put buying has been more popular than call buying during the past two weeks at the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX). In fact, the 10-day put/call volume ratio of 1.46 across these exchanges ranks in the 86th annual percentile.

Bullish or bearish, it's still a great time to buy premium on Autodesk. This is based on the stock's Schaeffer's Volatility Index (SVI) of 28%, which is in the 14th percentile of its 12-month range -- hinting at low volatility expectations for near-term options.

McDonald's (MCD) kicked off a busy week of big-cap earnings bright and early this morning, with the shares last seen trading up 5.2%. Dow stocks Merck & Co., Inc. (NYSE:MRK) and Pfizer Inc. (NYSE:PFE) could also be poised for potentially volatile trading, with both pharmaceutical firms scheduled to report first-quarter earnings before the open tomorrow, May 1.

Merck Options Traders Bet on a Round-Number Breakout

Over the past eight quarters, Merck stock has averaged a single-session post-earnings move of 2%, though this time around, the options market is pricing in a slightly higher 4% swing. It's been a flip of the coin as to whether the earnings reactions have been positive or negative, but the two most recent quarters have resulted in moves to the downside.

The stock has been racing higher since bottoming at a two-year low of $52.83 earlier this month -- thanks to optimism surrounding the company's Keytruda lung cancer treatment -- and was last seen up 13% at $59.63. However, this rally recently stalled out near the $60-$61 region, which coincides with a 61.8% Fibonacci retracement of the stock's late October sell-off, its 320-day moving average, and a short-term floor in January.

Options traders don't seem too worried about the overhead resistance, though. The May 60 call has seen the biggest rise in open interest over the past 10 days with 6,527 added, and data from the major options exchanges confirms mostly buy-to-open activity here. The last time Merck stock closed north of the round $60 mark on a weekly basis was Jan. 26.

Pfizer Call Writers Target Long-Term Technical Ceiling

Pfizer has moved 1.6% either way in the session after the company reports, looking back eight quarters. All but two of these post-earnings sessions have been negative for the stock, including the last four in a row. For tomorrow's trading, the options market is pricing in a 3.2% move for PFE, regardless of direction.

PFE is also headed for a big monthly win, up 3.8% so far in April to trade at $36.89. However, this rally really started in late March, when the security took a sharp bounce off its 320-day moving average -- a trendline that also contained Pfizer's pullback from its 15-year high of $39.43 from Jan. 29. The shares are now facing off with the $37.00-$37.40 region, though, which marked tops in December and February.

This level has caught the eye of options traders, too, with the June 37 call home to peak open interest of 38,101 contracts. The May 37 call is not far behind with 35,401 contracts outstanding, and data from Trade-Alert points to notable sell-to-open activity here back in mid-April when PFE stock was trading near $36.30.

The shares of Regeneron Pharmaceuticals Inc (NASDAQ:REGN) are lower today -- earlier touching a three-year low of $298.19 -- extending last week's slide sparked by partner Sanofi's (SNY) disappointing quarterly drug sales. Fellow pharma stock McKesson Corporation (NYSE:MCK), meanwhile, is modestly lower today, but fresh off a five-day winning streak and eyeing its best month in nearly a year. What's more, if history is any indicator, both REGN and MCK stocks could rally in May.

Healthcare ETFs Outperform in May

Over the past 10 years, healthcare stocks have done very well in the month of May. In fact, pharmaceutical exchange-traded funds (ETF) have been the best to own in the last decade, according to data from Schaeffer's Senior Quantitative Analyst Rocky White. The Health Care Select Sector SPDR ETF (XLV) has led the pack, ending the month higher 80% of the time, with an average gain of 1.31%. The SPDR S&P Biotech ETF (XBI) has generated the best average return of all, gaining 2.72% and higher 70% of the time. The SPDR S&P Pharmaceuticals ETF (XPH) has also ended the past seven of 10 Mays higher, averaging a gain of 1.75%.

Best Stocks to Own in May

It's no surprise, then, to find several healthcare stocks on our list of best S&P 500 stocks to own in May, looking back 10 years. REGN is the only stock that boasts a 100% win rate for the month, and has averaged the highest return -- 9.83%. MCK stock takes runner-up, with a win rate of 90% and an average monthly gain of 8.14%.

REGN Stock Rallied After Last May Earnings Reports

Regeneron stock has struggled since its June peak of $543.55, led lower by its 50-day and 80-day moving averages. As alluded to earlier, REGN stock fell to a new low south of $300 earlier, and was last seen 4.1% lower to trade at $300.10, despite the Food & Drug Administration (FDA) granting priority review for cemiplimab.

Regeneron is expected to report its own quarterly earnings before the open on Thursday, May 3. It's worth noting that REGN shares surged 6.7% the day after their report roughly one year ago, and jumped 4.7% after the May 2016 earnings release. Should the equity extend its trend of May gains, another 9.83% bump from current levels would place the drug stock around $329.60 -- back above its 50-day trendline.

A stronger-than-expected earnings showing could also spook a few analysts. Currently, REGN boasts 16 "hold" or worse recommendations, compared to just eight "buy" or better endorsements.

Short Squeeze Could Propel MCK Stock

McKesson stock has added nearly 12% in April, set to wrap up its best month since May 2017. The equity got a lift mid-month on easing concerns about Amazon (AMZN) competition in the pharmaceuticals industry, and last week rallied after the company issued upbeat guidance.

MCK shares are now trading back above their 200-day moving average, as well as a 50% Fibonacci retracement of their rally from late October to late January. After a five-day win streak, though, the stock is taking a breather, down 0.4% to trade at $157.57. However, the $162 area -- a 38.2% retracement of that rally -- has acted as a speed bump in the past.

Another 8.14% rally from current levels would put McKesson stock around $170.40 -- territory not charted since January, when the security was flirting with annual highs. What's more, a short squeeze could add fuel to the drug stock's fire. Short interest represents more than a week' worth of pent-up buying demand, at MCK stock's average pace of trading.

FireEye Inc (NASDAQ:FEYE) joins a busy line-up of earnings reports this week, with the cybersecurity firm slated to unveil its first-quarter results after tomorrow's close. The stock has a history of volatile earnings reactions, averaging a 10% next-day move over the past eight quarters, regardless of direction. This time around, the options market is pricing in an even bigger move of 15.4%, based on implied volatility data.

Last February, the stock gapped 9.3% higher the day after FEYE reported earnings -- sending the shares to a three-month high at the time. Since then, the security has added more than 16%. And while the shares have pulled back since hitting a two-year high of $19.36 on April 16, they have found a familiar foothold atop their rising 40-day moving average, last seen trading at $17.99.

Pre-earnings options traders have targeted this area of support in recent weeks. The weekly 5/11 18-strike put has seen the biggest rise in open interest over the past 10 days, and data from the major options exchanges confirms sell-to-open activity. While it's possible put writers are hoping FEYE holds above $18 through expiration at next Friday's close, they are likely betting on a post-earnings volatility crush.

Elsewhere on Wall Street, sentiment is much more skeptical of FEYE stock. While the majority of analysts covering the shares maintain a lukewarm "hold" rating, the average 12-month price target of $18.04 is in line with current trading levels.

Plus, short interest on FEYE rose 5.75% in the most recent reporting period to 15.38 million shares. This accounts for a healthy 8.78% of the stock's available float, and would take nearly a week to cover, at the average pace of trading. A positive earnings reaction could spark a round of upgrades and/or a short squeeze.

While healthcare stocks tend to be the best to own in the month of May, historically, motorcycle titan Harley-Davidson Inc (NYSE:HOG) and automaker Ford Motor Company (NYSE:F) tend to struggle. In fact, HOG sports the worst win rate for May of all S&P 500 stocks, with F stock not far behind. 

Below are the 25 worst stocks to own in May, looking back 10 years, according to Schaeffer's Senior Quantitative Analyst Rocky White. If past is prologue, traders may want to "sell in May and go away," at least as far as these stocks are concerned.

Lower Lows Could Be Ahead for Harley Stock

Harley-Davidson stock has ended the month of May in the red 90% of the time over the past decade. The equity has suffered a loss of 5.2%, on average, putting it at the top of our list of Worst Stocks for May.

Since touching a six-month peak of $56.50 in late January, it's been downhill for HOG shares. The security has dropped 28% in that time frame, with rebound attempts stalling in the face of its descending 30-day moving average. The stock was last seen 1.5% lower to trade at $40.51, and just off a new two-year low of $40.14.

Despite the stock's struggles in 2018, HOG has no shortage of call buyers. On the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), the stock's 10-day call/put volume ratio of 1.01 is in the 71st percentile of its annual range. This points to accelerated Harley-Davidson call buying relative to put buying of late.

Of course, some of those call buyers -- particularly those scooping up out-of-the-money options -- could be short sellers seeking an options hedge. Short interest represents more than 13% of HOG's total available float.

Whatever the motive, short-term Harley options can be had at a relative discount. The equity's Schaeffer's Volatility Index (SVI) of 26% is higher than just 11% of all other readings from the past year, indicating near-term HOG options are pricing in relatively muted volatility expectations at the moment.

Ford Stock Flirts With Key Trendline

Ford Motor stock has ended the month of May higher just 20% of the time over the past 10 years. The automaker has averaged a monthly loss of 3.28%, to be specific.

Today, F stock is down 0.4% to trade at $11.21, after U.S. auto sales slumped in April. As with HOG, Ford shares also suffered in a big way in early 2018, and despite the company's well-received earnings last week, the equity is still stuttering below its 200-day moving average. Further, the overhead $11.75-$11.80 level previously acted as support for F stock, and now represents a 50% Fibonacci retracement of the security's drop from January highs to March lows.

Still, Ford options traders have been more bullish than usual. The stock's 10-day ISE/CBOE/PHLX call/put volume ratio of 2.79 is in the 78th percentile of its annual range. And this time there's not an abundance of short interest that could point to hedging.

Likewise, the security's Schaeffer's put/call open interest ratio (SOIR) of 0.59 is in just the 20th percentile of its annual range, indicating near-term call open interest is more prevalent than usual, relative to put open interest. Peak open interest in the front-month May series stands at the May 12 call, and could act as an options-related speed bump for Ford shares in the near term.

Treasury yields made the news recently when the 10-year Treasury yield hit 3% for the first time since early 2014. Shorter-term rates have been increasing even faster. The spread between the 2-year and 10-year Treasury yields has narrowed to its lowest level since late 2007, just before the 2008 stock market crash. This week, I'm analyzing how stocks performed in the past based on the level and behavior of the yield spread.

Yield Spread In Free Fall

The chart below shows the spread between the 2-year and 10-year Treasury yields to be in free fall. It recently fell below 50 basis points, worrying some investors that it will soon be negative. The last two major market tops occurred when the spread was below zero.

Next, I put some numbers behind the chart above. I went back to 2000 and found the S&P 500 Index (SPX) returns going forward one year based on the yield spread. I grouped the returns into five brackets so that each bracket had the same number of returns. We recently just crossed into that top bracket in which the yield spread is below 50 basis points. At this level, the S&P 500 averages a loss of 2% over the next year, with less than half of the returns positive. The table makes it clear. Since 2000, the higher the yield spread, the better stocks have done.

However, the time frame you look at matters a lot here. If you take the data back just one decade, to 1990, then it paints a different picture. With the spread around 45 basis points, that puts it in the second bracket in the table below -- which has extremely bullish returns. That bracket has the highest average return, above 16%, and the second highest percentage of positive returns at 88%.

So which data should we look at? The table above is more recent, so you can make a case that it's more relevant to the current environment. On the other hand, the table below covers a longer time frame so has a bigger sample size. In my opinion, one thing that discredits the table below is the seemingly random returns of the brackets. You see outsized returns in the second and fifth bracket, while the other brackets are similar in performance.

 

Direction of Yield Spread Matters

Looking at the data since 2000, I broke down the returns in each bracket further by whether the yield spread was falling or rising. As you can see in the first chart above, the spread is currently decreasing. On the bright side, when the yield is less than 50 basis points, stocks have done better when the spread is narrowing. They still haven't done great, averaging a gain of 2.67% over the next year, with 67% of those gains positive. But compare that to when the spread is rising at that low level. In that case, the S&P 500 averages a double-digit loss with less than 15% of the gains positive.

Implications of a Sinking Yield Spread

You can see why the yield spread falling to extremely low levels has investors worried. Since 2000, when the yield spread falls at these levels, stocks tend to underperform. If the spread falls below zero and then bottoms though, that's an even worse scenario. In that case, you'll have a yield spread rising from an extremely low level. The table just above shows that's the worst environment for stocks.