Research.LeutholdGroup

Leuthold’s research team has recently flagged a number of items that suggest it may be time to consider small cap stocks. This asset class has been showing signs of life and the decision to overweight small caps is starting to seem relevant – and perhaps nicely profitable - again.

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At October’s close, a long-term BUY signal was triggered on the Russell 2000. The fact that some market segments are triggering “oversold BUYS” when blue chips are at record highs speaks volumes about the internal disparities that have developed during the last few years. The Russell BUY signal is not inconsistent with our belief that the action since the January 2018 peak remains part of a lengthy cyclical topping process.

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The six-month stretch beginning in May generally coincides with a narrow stock market in which non-cyclical and low volatility stocks tend to be the winners. Hence, don’t “sell” in May, but rather, tilt away from beta and away from “breadth.” These seasonal switching strategies have 70% batting averages.

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The old maxim says that when the bears have Thanksgiving, the bulls have Christmas.

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In the March Green Book, we discussed the long history of stock market difficulties during mid-term election years. Incredibly, nine of the past 11 cyclical bear market lows have occurred in these years, with eight of those nine recorded during the seasonally-weak months of May through October (Table 1).

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Our bearish stance could be tested by the arrival of the seasonally strongest six-month window of the four-year electoral cycle. Since 1926, November of the mid-term year through April of the pre-election year has produced an average un-annualized S&P 500 +16.4% total return.

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“That which does not kill us, makes us stronger” might be a good motto for this never-ending bull market. The bull continues to shrug off the effects of both Quantitative Tightening and an escalating trade war, and it’s doing so during a seasonal stretch in which many of its predecessors have sunk to their knees (if not their demise).

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While the FANGs—and, lately, the Dow stocks—are the market’s undisputed leaders, it’s difficult to argue the market has narrowed in a fashion that’s indicative of a “distribution” phase.

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Last year’s “low-risk” BUY signals from our Very Long Term (VLT) Momentum algorithm have proven very profitable, but enough time has elapsed that they should no longer be considered an important bullish factor.

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We’ve seen several pundits’ analyses of the “Sell In May” phenomenon of late, but none of them has addressed the most salient feature of this anomaly, which is that it’s historically been a predominantly Small Cap phenomenon.

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While 2016 is shaping up to be one of the most difficult years ever (on a relative basis) for active equity managers, one cannot blame the usual culprit of “narrow” market participation.

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We’ve mentioned that concerns over potential seasonal weakness in September and October seem pronounced this year, perhaps because the year has so far turned out a pleasant surprise following its horrendous start.

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If this year’s interest in the “Sell In May” phenomenon is any indication, there remains plenty of skepticism surrounding the market’s recent rebound. The good news is that the “Sell In May” play has been weakest during presidential election years.

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We reviewed 100 years of evidence for the Dow Jones Industrials Average and found no compelling evidence for a “bounce” effect. Contrary to expectations, fourth quarter Dow performance has (on average) been stronger when the index has already booked a gain through the first nine months.

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Seasonality rests one rung above witchcraft in the pecking order of respected analytical techniques, yet our studies haven’t been able to refute its validity. We simply don’t understand why calendar phenomena that have persisted for decades should still be around.

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Considering the Major Trend improvement, new bull market highs (Nov. 6th) on the S&P 500, DJIA, and DJ Transports, we present a list of talking points we’d use if forced to make a bullish stock market case.

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Three months ago, our “Of Special Interest” section reviewed the historically pronounced effect of the well-known “Sell In May” phenomenon during mid-term years of the presidential election cycle.

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We stop short of embracing any sort of fixed stock market time cycle, but it's statistically difficult to discredit certain calendar patterns.

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This does not only apply to stocks, it applies to just about all risky assets.

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Leadership isn’t warning of impending weakness in either the U.S. economy or the stock market. Market breadth, on the other hand, is highlighting risks that aren’t evident when inspecting leadership alone.

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Those inclined to sell in May should sell Small Caps. If you don’t have Small Caps, sell Cyclicals, at least for the next six months.

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While the “Sell in May” market phenomenon has become part of Wall Street lore, the sector implications of this seasonal pattern are less well-known.

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We wondered whether or not strong relative sector price action during January tended to persist for the remaining eleven months of the year. During the last 16 years, evidence proves that the strength does persist.

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A look at the January barometer, indicates there is not much evidence that a weak January market portends weak performance in the remainder of the year.

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The January effect still lives…..it just comes a month earlier in December.

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Octophobia 2003…..The stock market has nothing to fear but fear itself. The financial system is awash in liquidity, the economy stronger than anticipated and investor confidence is returning.

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Remain bullish on the stock market, but don’t expect Main Street to be a major stock market factor in 2003. Today’s bull market expectations for the DJIA, S&P, and NASDAQ.

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The “seasonals” were with us, but have yet to produce positive results. “V” shaped economic recovery conviction stronger than a month ago.

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Looking Back: The best thing about 2001 is that it is over. Looking Forward: The seasons are with us as January is statistically the strongest month of the year.

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Bear market broadened out in late March to include other than technology sectors. Never before have so many lost so much.…There is plenty of blame to go around. Academia, The Street, the Media, the “Experts” to name a few.

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It’s no secret that the term “January Effect” has taken on a different meaning in recent years. Once a reference to the price bounce that underperforming small caps stocks receive as year end selling pressures dissipate, it has now been adopted by commentators to describe the unconstrained rally of large cap stocks, as the seasonal flood of cash pouring into big cap growth funds is invested

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The public is back as evidenced by strong mutual fund cash inflows. Seasonally strong Q1 mutual fund inflows should push the DJIA above 10,000. Traditional “January Effect” may be absent again in 1999, as it has previous four years.

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Public confidence measures have taken some sharp declines in recent weeks but mutual fund investors have cautiously returned as net buyers. Meanwhile the mountain of cash in U.S. focus equity mutual funds has climbed to $125 billion.

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After wavering in neutral several weeks, Major Trend Index turned negative November 24...Go to sidelines. Market rallied strongly in November but fund investors uncharacteristically stayed on the sidelines. Is this increased caution or seasonality?

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Major Trend Index faded to High Neutral in August, but will likely be propelled back to Positive by strong September 2nd market…Valuations still off the charts, but new valuation era looks like it’s still with us.

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Balanced budget agreement assumes current economic expansion will run about 12 years, longer than any other in history.

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The stock market performed pretty much as expected in August, although experiencing a somewhat unusual fade at month end. Major Trend remains negative. Some improvement but still a long way from Neutral.

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No January effect this year. It was a large cap show, with the DJIA (+5.4%) outperforming 85%-90% of stock groups and sectors for the month and the S&P trouncing about 70%.

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Weighing In: Updating positives and negatives for stocks...adding earnings momentum as a positive.

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Weighing In: Updating positives and negatives for stocks...technology leadership is fragmenting — shifting this positive to neutral.

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