As I pointed out recently, 2015 is off to a rocky start with the S&P 500 Index down 2.4 percent so far in January. Volatility is on the rise in most markets; commodities, currencies, bonds and stocks included!
Yet January is usually one of the best months of the year for stocks. In fact, the S&P 500 Index rose 63 percent of the time in all Januarys since 1928, while posting an average gain of 1.24 percent.
But in spite of the increased volatility to start the year, there are two very good reasons to believe stocks can regain their footing and go on to post gains in 2015:
Bullish seasonality and the cyclical nature of markets
According to Wall Street lore, “as January goes, so goes the year.” And the historical data backs up the claim that January’s performance correctly points out the direction stocks will take over the full-year on a pretty consistent basis.
According to data compiled by our friends at the Stock Trader’s Almanac, the so-called January Barometer has an 87.7 percent accuracy rating since 1950!
Going back even further, to 1928, analysis by Merrill Lynch reveals January is the third-best performing month of the entire year in terms of average percentage gain, and it’s the second-best month when it comes to the consistency of positive returns.
The cyclical nature of markets tells us that certain patterns tend to recur. They don’t repeat exactly of course, but directional trends in stocks, bonds and other markets do tend to repeat over time.
According to the Presidential cycle, 2015 is Year 3 of this four-year pattern. And during this period, stock returns are even stronger in January (up 3.5 percent on average) and gains are more consistently positive (up 86 percent of the time)!
We’re now in the midst of the sweet-spot when it comes to the Presidential cycle. In fact, there are several top performing months still ahead for investors:
* The first quarter of Year 3 (January-March 2015) is up 81 percent of the time, with an average gain of 5.7 percent for the S&P 500, and …
* The second quarter of Year 3 (April-June 2015) is up 71.4 percent of the time, with the S&P 500 gaining another 4.7 percent on average …
* That’s a compound total return of 10.7 percent on average from January through June, according to the Presidential cycle!
But it gets even better.
A rare “yield inversion” that says stocks are undervalued
Investors endlessly debate market valuations. Are stocks too expensive or too cheap? It really all depends on what yardstick you chose to use. But one long-term valuation indicator just delivered a very rare and compelling buy signal for stocks.
The dividend yield on the S&P 500 stock index recently surpassed yields on 10-Year U.S. Treasury bonds. As you can see in the chart below, this is a very uncommon event, and has been very bullish for stocks in the past.
As you can see at far left in the chart above, bond yields are normally higher than the dividend yield of stocks, and usually far higher. In the early 1980s for example, bonds offered double-digit yields!
That was a great time to buy bonds and lock in yields of 15 percent plus for the next decade. Plus, you would have enjoyed substantial capital gains from those bonds as interest rates declined.
The dividend yield on stocks moved above 5 percent for several years in the 1970s and early ’80s, but that’s about as good as it gets.
In the long history of financial markets the yield on stocks is below bond yields the vast majority of the time, usually far below.
But there are rare instances when this normal relationship inverts. Now is one of those rare instances, and it could lead to substantial gains in stocks over the next six months of 33 percent or more!
The first time this yield inversion happened, at least in modern history, was 1958 when dividend yields rose to 4.15 percent, while bonds yielded just 2.9 percent. Stocks paid you almost 50 percent more in dividend income than bonds.
The normal relationship between stocks and bonds had inverted, and it was telling you loud-and-clear that stocks were substantially undervalued relative to bonds.
* That was a bullish buy signal for stocks. And sure enough, one year later the S&P 500 had soared 39 percent.
* The bullish yield inversion happened again in 1962, and 12 months later stocks were up 33.4 percent.
* Investors had to wait 46 years for the next buy signal, but patience paid off with not one but TWO buy signals for stocks less than three years apart.
* In November 2008, during the financial crisis, bond yields once again slipped below stock dividend yields — a year later the S&P 500 was 35.7 percent higher.
* And in August 2011 yields inverted again, with the S&P 500 delivering gains of 25.4 percent over the next 12 months. You can see these last two inversions circled in the chart above.
The yield inversion buy signal flashed only four times in the past 60 years and stocks gained an average of 33 percent within the following year.
And we just got buy signal #5, only a few weeks ago as shown by the green arrow in the chart above!
Bottom line: Notwithstanding the volatile start to 2015, seasonal stock market trends are working in the bulls’ favor right now, and this bullish tailwind should continue to push stocks higher through at least mid year.
Plus, the stock vs. bond yield inversion is flashing a bright green buy signal for stocks right now, telling us the S&P 500 could gain 33 percent or more over the next 12 months.
While markets could stay turbulent for awhile longer, considering all the tricky cross currents at work, I’m focusing on the highest quality stocks and ETFs with the best relative price strength; those most likely to be market leaders when the uptrend resumes.