The power of momentum
History indicates further gains in coming months.
Merrill Lynch noted last week there have been 34 years since 1928 that the S&P 500 gained more than 10 per cent during the first 10 months of the year.
Subsequent November-December gains followed 28 times.
Quantitative blog PastStat went further in its analysis, tests showing the index has risen on 24 out of 27 occasions since 1950 when the S&P has risen by 10 per cent or more during the first 10 months.
When the S&P has been up more than 15 per cent, gains have followed on 15 out of 16 occasions, with an average gain of 5.25 per cent in the last two months of the year.
This is no seasonal fluke – rather, it is testimony to the power of momentum and augurs well for year-end gains.
S&P 500 continues its striking climb
The S&P 500 rose almost every day during the second half of October, taking its 2013 gains to almost 25 per cent, and sentiment is now looking exuberant.
The latest American Association of Individual Investors poll shows just 17 per cent of investors are bearish – well below its long-term aver- age (30 per cent) and at levels rarely seen over the last decade.
Bearishness is even less evident among investment newsletter writers, as measured by the weekly Investors Intelligence survey, the current reading on a par with the lowest levels of the last 20 years.
Equity exposure recommended by Nasdaq commentators, as tracked by Mark Hulbert’s Newsletter Sentiment Index, is at levels that have marked short-term tops over the last two years.
Weekly inflows into long- only US funds recently hit a nine-month high.
However, hedge funds are taking a different cue, with net sales recently hitting their highest level since December 2008.
It is easy to view this as a classic “dumb money versus smart money” clash, but bears should be cautious. For one, hedge funds have been sceptical since 2009. Secondly, while excessive bearishness is associated with market bottoms, timing tops has always been more difficult.
Indices are vulnerable when sentiment gets frothy, but declines tend to be brief, with bulls likely to pounce on any short-term pullback.
Small caps punch above their weight
Improving economic sentiment has seen the small-cap Russell 2000 index soaring 32 per cent in 2013, dwarfing the large-cap Dow’s 19 per cent gain.
The index, whose average company has a market value of $1 billion compared to the Dow’s $150 billion, has risen three times as fast as the Dow since the end of June.
Bloomberg notes that small companies are beating analyst estimates by more than twice the rate of Dow companies. Analysts project small-cap profits will race ahead again next year. Since March 2009, the Russell 2000 has gained 230 per cent, the Dow 140 per cent. In fact, small caps have out- performed for 13 years now. That’s unprecedented over the last 88 years, Wisdom Tree strategists noted recently, and almost twice as long as the average cycle.