If there were nominations for a theme song to describe how the S&P 500 index has traded this year, I would suggest “Road to Nowhere” by The Talking Heads. Since early February, the large-cap index has not moved very much. Has it fluctuated on a day-to-day basis? Absolutely. But when one takes a step back, the relative lack of overall price movement becomes more obvious.
Investment firm Driehaus Capital Management summed it up in a tweet: “S&P 500 mired in the narrowest 6M trading range…ever…by wide margin.” Assistant portfolio manager Yoav Sharon cited data showing the large-cap index as trading in a 4.44% range during the six-month period ended August 13, 2015. In other words, the difference between the high and low closing prices set by the S&P 500 over the past six months is a mere 4.44%. (If the six-month period is reset to end as of today, the trading range is 4.67%.)
To put this number in perspective, the S&P 500 has had a six-month range that fluctuated less than 6% just five other times. Those six-month periods ended during August 1993 (5.26%), March 1965 (5.3%), March 1994 (5.36%), November 2005 (5.8%) and August 1972 (5.8%). Every other six-month period has had a six-month trading range of 6.0% or greater. The 20th narrowest six-month trading range, which ended in September 1960, had nearly 70% more volatility (7.28%) than the current six-month range.
Of course, what happens with one particular index may not be indicative of what is occurring with your personal portfolio. Some stocks have been very volatile this year. Others likely have been in an even tighter trading range. What the index numbers do show, however, is how the daily reporting of the market’s movement can easily distort one’s perception of the true ongoing trend.
To be fair, on a daily basis the markets have been somewhat volatile this year. Including today, there have 35 days when the S&P 500 has risen or fallen by more than 1% based on historical data from Yahoo Finance. (For those of you who are curious, there have been 20 days with a gain of more than 1% and 15 days with a decline of greater than 1%.) In comparison, there were just 38 days when the S&P 500 closed up or down by more than 1% in all of 2014 as well as in all of 2013. In other words, Mr. Market is on pace to easily surpass the volatility of the previous two years even though the S&P 500 hasn’t very changed much in terms of its overall trading much over the past six months.
As I was writing this week’s commentary, I corresponded with Alan Ellman of The Blue Collar Investor about option premiums (prices). Since option premiums factor in volatility, I presumed that the narrow trading range has reduced them. (I am not an options trader or one who engages in covered call writing, however.) Alan responded by saying that while the S&P 500’s narrow trading range has lowered option premiums, severe spikes in volatility can create higher premiums. And as is the case with broad indexes and individual securities, the premiums of specific options can vary widely even in a flat market.
As far what the narrow trading range means for future returns, we shall see. Mr. Market never heads in one direction continuously. He speeds up, slows down, staggers and, at times, goes backward. One never knows with absolute certainty in what direction or at what pace he’ll move next. History does show a variety of return scenarios with very good years followed by either pauses or down years. It also shows bad years followed by good years—a pattern described as reversion to the mean. While arguments can be made for the current trading range to end with a breakout to the upside or to the downside (and today's close was the lowest since January 21, 2015), realize that the future usually unfolds in a way we don’t expect it to.
- Recognizing Chart Patterns: A Guide to Spotting Price Trends – In this 1999 AAII Journal article, Wayne Thorp explained how to use trendlines to make sense of movement in stock prices.
- A Comprehensive Approach to Covered Call Writing – Alan Ellman’s guidance on writing and managing covered calls.
- Do You Focus More on Daily or Longer-Term Price Action? – Tell us on the AAII.com Discussion Board.
There were no changes made to either the Model Shadow Stock Portfolio or the Model Fund Portfolio.
Six stocks in the Model Shadow Stock portfolio qualified for purchase at the end of July: L.S. Starrett Co. (SCX), Rocky Brands (RCKY), Salem Media Group (SALM), Universal Stainless & Alloy (USAP), Vishay Precision Group (VPG) and Willis Lease Finance Corp. (WLFC). Qualified stocks are companies held within the portfolio that currently meet the purchase rules. Among that group, Universal Stainless & Alloy and Vishay Precision Group were recent additions as of June 2015.
No stocks currently in the portfolio are approaching their value or size limit. Furthermore, no stocks are currently on probation for producing negative earnings over the last four quarters. Were a stock on earnings probation or approaching a value or size limit, it would be a potential sell candidate at the next quarterly review in September.
The Model Fund Portfolio declined by 0.7% in July, while the Model Shadow Stock Portfolio, which invests in micro-cap value stocks, was down 6.0%.
The Model Shadow Stock Portfolio’s underperformed both of its comparison benchmarks: The Vanguard Small Cap Index fund (NAESX) declined 0.3% and the DFA U.S. Micro Cap Index fund (DFSCX) was down 2.4%. The Model Shadow Stock portfolio was hurt by weak performances in July from Rex American Resources (REX), SigmaTron International (SGMA) and Universal Stainless & Alloy (USAP); these three companies accounted for more than half of the portfolio’s decline in July. Year to date, the Model Shadow Stock Portfolio has declined 2.6%, while the Vanguard Small Cap Index fund is up 3.8% and the DFA U.S. Micro Cap Index fund is up 1.7%. Since its inception in 1993, the Model Shadow Stock Portfolio has a compound annual average return of 16.3%, while the Vanguard Total Stock Market Index fund (VTSMX) has gained 9.3%.
The Model Fund Portfolio’s 0.7% decline in July compared to a 1.6% increase for the Vanguard Total Stock Market Index fund. Since its inception in June of 2003, the Model Fund Portfolio has a compound annual average return of 8.9%, slightly trailing the Vanguard Total Stock Market Index fund over the same time period, which gained 9.4%.
Only 12 members of the S&P 500 are scheduled to report earnings as second-quarter earnings season wraps up. Among them are Best Buy Co. (BBY) on Tuesday; Avago Technologies Ltd. (AVGO) and Brown-Forman Corp. (BF.A) on Wednesday; and Dollar General Corp. (DG) on Thursday.
The first economic reports of note will be July new home sales, the Conference Board’s August consumer confidence index and the June S&P Case-Shiller home price index. July durable goods will be released on Wednesday. Thursday will feature revised second-quarter GDP and July pending home sales. July personal income and spending and the final August University of Michigan consumer sentiment survey will be released on Friday.
Atlanta President Dennis Lockhart is the only Federal Reserve official to speak. He will make a public appearance on Monday.
The Treasury Department will auction $26 billion of two-year notes on Tuesday, $35 billion of traditional five-year notes on Wednesday and $29 billion of seven-year notes on Thursday. The Treasury Department will also auction $13 billion of two-year floating rate notes on Wednesday.
- Social Security Strategies for Couples
- The Cash Flow Statement: Tracing the Sources and Uses of Cash
- Creating and Following a Real Financial Plan
Neutral sentiment’s rise in this week’s AAII Sentiment Survey kept it above its historical average for a record 33rd consecutive week. The previous record of 32 consecutive weeks was set last year. This week’s rise in neutral sentiment occurred as both optimism and pessimism declined.
Bullish sentiment, expectations that stock prices will rise over the next six months, pulled back by 3.6 percentage points to 26.8%. The drop keeps optimism below its historical average of 39.0% for the 24th consecutive week, the longest such streak since a 29-week stretch in 1993.
Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rebounded by 6.4 percentage points to 39.8%. The rise keeps neutral sentiment above its historical average of 31.0% for a record 33rd consecutive week, as noted above. The previous record streak of 32 consecutive weeks was set between January and August of last year.
Bearish sentiment, expectations that stock prices will fall over the next six months, fell 2.8 percentage points to 33.3%. Even with the decline, pessimism is above its historical average of 30.0% for a fourth consecutive week. The last time bearish sentiment was last above its historical average on four consecutive weeks was between April 11 and May 2, 2013.
Bullish sentiment is back at an unusually low level. Such readings have historically been correlated with above-median returns for the S&P 500. (There is no guarantee that history will repeat, however.) Neutral sentiment is right at the top end of its typical historical range.
The record streak of above-average readings for neutral sentiment has occurred as the S&P 500 has been essentially flat for several months. According to Driehaus Capital Management, the S&P 500 fluctuated within a 4.44% range during the six-month period ended August 13, 2015. As discussed above, Driehaus describes this as the narrowest trading range on record.
Giving AAII members reasons for caution are concerns about the possibility of a sizable decline in stock prices occurring, the pace of economic growth, the lack of wage growth, valuations, the impact of the stronger dollar on earnings and geopolitical events. The lack of market breadth and ongoing daily volatility on are also playing a role. Keeping other AAII members optimistic is the Federal Reserve’s still-accommodative monetary policy, the ongoing bull market, sustained economic expansion and earnings growth.
This week’s special question asked AAII members what one thing about the current market environment they would change if they had a magic wand. We received a wide variety of answers, but were able to group the responses into broad categories. The largest group of respondents (21%) singled out the Federal Reserve, with many calling for either an increase in interest rates or clarity on the timing of the first rate hike. Equal numbers, about 13% per group, want a change in government policies or a change in market conditions. Those wanting a change in policies discussed the tax code, regulations (both for and against) and reducing the federal debt. Lower volatility was the most desired change in market conditions, though some members want prices to fall in order to reduce prevailing valuations. An additional 8% would like to see less short-term trading and thinking. China was cited by 9% of respondents, with individual investors wanting stronger economic growth or a more freely traded yuan.
Here is a sampling of the responses:
- “Get the first rate hike over with already. It’s not as big of a deal as people make it out to be.”
- “Stop the large up and down action.”
- “I would like to see a realistic plan to balance the federal budget.”
- “Not allow China to manipulate their currency.”
- “Stabilization in crude oil prices, so that the oil industry might recover.”
- “I wish median P/E ratios were lower.”
Bullish: 26.8%, down 3.6 points
Neutral: 39.8%, up 6.4 points
Bearish: 33.3%, down 2.8 points
Bullish: 39.0%
Neutral: 31.0%
Bearish: 30.0%
Local Chapter Meetings
August 13, 2015 Timing Matters When Analyzing Investment Returns
August 6, 2015 Using Debt to Find Attractive Small-Cap Stocks
July 30, 2015 Don’t Judge Diversification by Its Short-Term Performance
July 23, 2015 Harder to Value Stocks When Interest Rates Are Uncertain
