- A large number of stock market "rules" and indicators exist today, predicated on extrapolating conclusions from slicing and dicing historical data—often to corroborate a predetermined concept.
- Statisticians have proven stock prices are not serially correlated—meaning historical price movement by itself has absolutely no bearing on future stock movement.
- If investors heeded the old investing adage and "sold in May," they would have missed a 16.5% rise in the S&P 500.
- Instead of following "rules," look to fundamentals to show where markets are heading.
What if we told you there was a statistic that explained 75% of S&P 500 returns for the past 13 years? And this statistic, if used in conjunction with two more sets of data, nailed past S&P 500 returns with 99% accuracy? What is this amazing statistic? Annual Bangladeshi butter production. Sound hokey? It is. A veteran money manager devised this bizarre "butter indicator" to show how ridiculous data mining could be.
A large number of stock market "rules" and indicators exist today, predicated on extrapolating conclusions from slicing and dicing historical data—often to corroborate a predetermined concept. Unfortunately, a large number of investors fall prey to these seemingly predictive "strategies." History is a useful guide for baseline expectations, but it can't be given that history will accurately predict the market's exact next movement. Statisticians have proven (over and over again) stock prices are not serially correlated—meaning historical price movement by itself has absolutely no bearing on future stock movement.
Some investors today are betting volatility will increase as September approaches. Why? Historically, September's US stock returns are the worst among the calendar months. Plus, the recent sizeable market rally is raising fears the market is due for a pullback. Does this mean investors should sell out of stocks before this injurious month arrives?
Keep in mind, September returns have averaged -1.3% since 1928—a number more subdued than some of the daily gyrations we've seen recently. Plus, average numbers tend to leave out the details—including the fact September returns were positive in 1995 (4.2%), 1996 (5.6%), and 1997 (5.5%).* The idea that a particular month has anything to do with stock returns is a big mistake.
Take the investing adage, "Sell in May and go away." It rears its head every spring, but investors taking heed this year would have missed a sizeable part of the recent rally. The S&P 500 rose over 10% from the end of May through August 7—and over 16% from the beginning of May.* And that's the major flaw with strategies based on data mining—they only "work" in hindsight.
Instead of following "rules," look to fundamentals to show where markets are heading. US corporate earnings as of last week were 13.8% higher than estimates—the best on record. US factory orders, minus transports, rose 2.3% in June, and US construction spending was up 0.3%. UK, German, and French manufacturing data for June beat forecasts. And only a fraction of the global stimulus has been deployed so far. Economic data isn't rosy across the board, and it won't be for some time. But for markets, relative expectations matter.
Pullbacks and volatility (both up and down) are to be expected—and are normal—during market recoveries. Beware anyone trying to explain these movements with rules, indicators, gadgets, and gizmos—or better yet, recall the Bangladeshi butter indicator.
*Source: Thomson Datastream