The Compound and Friends - Year End Rallies (with Josh and Tony Dwyer)

Episode Date: November 8, 2019

The S&P 500 came into October this year up double digits. It has done so on 42 occasions since 1926. That’s almost 50% of the time.  Of those 42 times, in 35 cases the market went up through the end of the year. That’s an 85% success rate, about as one-sided as market statistics can get.  On only 7 occasions did it fall in the fourth quarter.  BUT.... The 3 worst Q4 losses ever all occurred with the market up double digits - these worst Q4 drops ever were 1929, 1987 and last year -28%, -23% and -14% So most of the time when stocks are already up they continue to go up. but sometimes they also get crushed. The average gain is 4.5% (even including the losses). this is also the 24th time the S&P has been up 20% or more through 3 quarters of the year. We talked with famed Wall Street strategist Tony Dwyer about the tendency for markets that have a good three quarters to finish strong, and why this year looks like it should fall in line with the historical data.  1-click play or subscribe on your favorite podcast app   Subscribe to the mini podcast on iTunes or Spotify    Enable our Alexa skill here - "Alexa, play the Compound show!"   Talk to us about your portfolio or financial plan here:  http://ritholtzwealth.com/   Obviously nothing on this channel should be considered as personalized financial advice just for you or a solicitation to buy or sell any securities. Please see this 3,000 word terms & conditions disclaimer: https://thereformedbroker.com/terms-and-conditions/ Hosted on Acast. See acast.com/privacy for more information. Learn more about your ad choices. Visit megaphone.fm/adchoices

Hey, it's Josh Brown. I'm here live at the compound with my friend Tony Dwyer of Canaccord Genuity. Tony is one of my favorite people to have on the channel. We've had him here before. You guys love the video. And we're going to talk about the tendency for the stock market to rally into year end. Some crazy statistics and Tony's insights are second to none. So stick around. Okay, first of all, Tony, thanks for coming and for addressing appropriately for the channel. Buddy, I am so millennial. I really appreciate it. I want to talk to you about a phenomenon that everyone is vaguely aware of. We did some digging into the numbers and we're just blown away at the tendency for the market

in the first three quarters of the year year it's doing well to really explode into year end. And that is the situation we find ourselves in here at the end of 2019. So let me just get your impression of this. The S&P 500 came into October of this year up double digits. That's happened 42 times since 1926. So about half the time, the markets are up double digits coming into Q4. Of those 42 times, in 35 cases, the market went up even more into year end. That's about an 85% success rate. That's as good as you get in market stats. On only seven occasions did it fall in the fourth quarter after being up so strongly. But here's the caveat. The three worst fourth quarter losses ever were in those years. And that would be 1929, 1987, and last year.

Down 28%, 23%, and 14%, respectively. So most of the time when stocks are already up, they continue to go up, which as a trend following person, everyone would agree on that. But then sometimes when that doesn't work out, like last year, they get absolutely crushed. So the average gain in Q4 when you're up double digits is four and a half percent. Why do you think that takes place? Is it all behavioral? Is it all psychological? I really think it is. I really do, Josh. When you think about it, as a portfolio manager, you do a great job as a portfolio manager. For the first three quarters of the year, you're always thinking, when I did it at one point, well, it's all right because I still have the rest of the year to figure it out. When you get up to end of September, end of October, the rest of the year isn't that long.

We did the same kind of study when the first three quarters of the year are up, and we found the same thing. But think about what you said. This is awesome when it comes to human nature, right? 1929, 1987, and 2018. You notice there's kind of a gap in between those years, right? And everybody's screaming about how we could have a replay of last year. And it's set up. It's it couldn't be more opposite than it was last year as well.

We talked about eight months ago. Right. And our three recession indicators. But at the end of the day, there's a there's a big spread between when you have a really bad fourth quarter and it doesn't appear likely. Right. So this is the 24th time back to 1926 that the S&P has been up more than 20% going into year end. So that's about a quarter. I mean, people are looking at this year like it's an anomaly. I think to some extent we had so much headline volatility, so little stock market volatility.

And then people are saying, this is strange. A quarter of the time, this is the position we're in in October. We're up more than 20% into the year. I think people, they look at the historical return where it's 7% per annum real return in the S&P 500. And they're thinking, okay, maybe it's plus or minus 7%. It's either down or it's up really big. Well, you don't have any average years. There's very few average years. And so what drives it up really big is always monetary

policy and interest rates. We keep trying to recreate the wheel like human nature somehow is different. It's never different. You have pressure in the fourth quarter to make sure as an active portfolio manager that you're outperforming the indices. Otherwise, why wouldn't you just argue for going passive investment? So this year, statistically, the active managers have done better than I think most of the years during the recovery since the great financial crisis. Like the stats aren't as bad as they normally are.

Does that lend itself to more risk-taking and more concentrated positions or the opposite? Do people now play it safe and go back to the FANG names or, you know? So, you know, the Barron's Big Money Poll came out this last weekend, right? And the lowest number of bulls are positive people in over 20 years. It's a 27% or something? Right. And last night, when I looked, I couldn't find below 38%, and I got to check that. But at the end of the day, the lowest level of bulls in over 20 years,

with the economy still positive, the market up 20%, making a new record high. Active managers have become defensive because they don't want to give up the year. They came into the fourth quarter expecting a potential of what you outlined, the three years where you're going to have a big, bad fourth quarter. And it's not happening, which forces a scramble. Because then all of a sudden, the active management that was outperforming may now start underperforming. Because it's too defensive.

Correct. So if you're playing defense right now, you're in utilities, REITs, and we can talk about this as much as you want. People don't understand that when the Fed is easing monetary policy, it's pro-growth, which means your long-dated maturities, your treasury securities should go up in yield. Right. Right? Because it's a stimulative behavior. We have a little bit of a curves curve steepening now after the right also You know all summer we were freaked out about the inverted yield curve now. We have a little bit of steepening It isn't really is it what it comes down to is Banks are willing to lend and the corporate credit market is it open so companies have plenty of money

Households have plenty of money and what typically happens after an inversion of the yield curve is that you get this flip-flop around the zero level for a while. It doesn't just invert once. There's a long lead time to the next recession. What most people also don't realize, and we talked about it last time, is the market traditionally over the last three cycles was up 34% median from the date of the initial inversion, which happened a couple of months ago on the 210 spread, which means we've got a long way to go. Even if you use all the data since 1954, up 21.5% over each month. Why does it do that? Because the Fed then reacts and lowers rates, which then boosts the market. Whether or not you avoid recession in the end is not the point. The point you're making is the rally from the inversion

is fairly powerful. And arguably, we've been seeing it this fall. The messaging doesn't get to bankers quickly. So in other words, let's say you invert the yield curve, right? And it generally happens pretty quickly. So you invert the yield curve. Banks at that point are still lending. Like you haven't gotten down to the local branch managing lending officer and told them to stop lending. So all of a sudden, you had rates go from three and a quarter down to one and a half at a time where banks are still lending. And that happens every cycle.

So the drop in rates. So for example, my assistant refinanced her loan for $400 a month. We were at the Fast Money Show talking about that. One of the guys there said, hey, I just did that for $1,200 a month. So what happens is the rates, treasury yields come down hard. People get to refinance their loans because the banks haven't shut it down yet. I saw that refinancings were up more than 100% year over year. Did you see that stat?

Yeah, it's incredible. It's incredible. That's a huge part of the story. How do you- Or why is it incredible? Why wouldn't we expect that? It's not. It's every cycle and every cycle we think human nature is different. The guys printing the money keep telling us that they're going to print more money. Now, what we do, Josh, you and I in this business on TV, we try and figure out is that good or bad, right or wrong? And it doesn't matter. What matters is my assistant and the guy at Fast Money refinance their loan, which is a lot of spending power. So you talk to hundreds, maybe even thousands of portfolio managers throughout the course of the

year. How are people feeling given that we're a plus 20% on the S&P? So in line with that Barron sentiment poll, is that what you're encountering? Or people just like, we're dead any minute. Are people feeling that way? It's not we're dead any minute. It's like we could be dead any minute. There's too much debt. And as you and I know, you cannot fix debt with exponentially more debt. That's not going to end well. You can't grow the economy out of a debt problem. No.

And basically, so what we have is I call it bumper bowling. You know, when your kids, when they were little, you go, because nobody can lose in anything in the world anymore. You go bumper bowling. So when you can't get a gutter ball, 3% is the left. That's how I do it. I do it too. Except somehow I bounce it over one of them. Anyway, I digress.

In bumper bowling, the left bumper is 3% interest rates. When the US Treasury gets to 3%, there's so much debt that people can't afford the debt. Yeah, well, Congress can't fund itself at that level. We all know that what's keeping this whole thing going is low rates. 100%. know that what's keeping this whole thing going is low rates. A hundred percent. Why anybody would think that we're going to get higher rates absent like an inflation panic. Which you can't get without extraordinary growth. Yeah.

Right? So how do you, so the whole point is your left bumper is you can't get too great a growth. So what's the right bumper? So the right bumper is 2% because all the people that do debt, that take out debt between 2% and 3% get to refi below 2%. And that's exactly what we're seeing. So the portfolio managers that I talk to, they're not negative. They're not saying, wow, we're about to go into recession, although that's popular commentary right now.

They're saying, okay, bond yields came down so far that they became defensively positioned in utilities, REITs, and consumer staples. The bond surrogate trade. Those seconds have done incredibly well this year. And we found that we're in the third, again, making it not unique, we're in the third post mini-recession recovery of this cycle. We keep looking for what we already found. People keep saying, OK, we might go into recession. We're in a manufacturing recession again, like the other two.

And in both of those cases, yields on the 10-year went from 3% down below 2% to 1.5%. Yeah, we had a sub-rosa recession in 15 and 16 from oil prices collapsing. How about Europe in 2011-12? Remember the acronym PIGS, Portugal, Italy, Greece, and Spain? And you had an accompanying S&P bear market. By October of 11, we were down 20%, resetting the bear market, essentially. So what if we have to redefine, based on bumper bowling of rates, what a recession looks like in the US? Because manufacturing-

What if they happen faster and they don't show up in everything? Like in the 1950s, you had four, and this is my thing, I'm a historian, right? In the 1950s, from 1949 to 1968, four recessions, Josh, you had five bear markets. Right. Right? No, four bear markets. And those recessions were so shallow, but it was a more manufacturing-based economy. I think the 1950s was either the second or third best stock market performance

of any of the decades. Outside of the 90s. So it goes to show. Right? And that's what we're in. So we're in a recession. The 1950s, 80s, I think, is the hierarchy. But it was an amazing time.

That's right. That's exactly right. It was an amazing time. And you did just what we're doing now. So the question I'll ask you is, what if we're nine months into an economic and market cycle instead of 10 years into it? We love to paint the picture. Oh, it's the longest economic recovery.

It's the longest bull market in history. Well, unless you think 19.8% isn't 20%, we've had a bear market. We're nine months into a new bull market. Oh, in December. Absolutely. The other thing is that we've been in this kind of secular bear since January or February of 2018. It's almost a full two years. That's right.

Where the stock market has not made a new high. I mean, I think right now we're on the verge of doing it, but- Well, you're bringing out a wicked pet peeve. It's a new bull market. It's a totally, it's a new bull market. It's a totally new bull market, but my pet peeve is when we go on TV and say the market's done nothing since January of 18. I just said it. It went down 20% and then up 20%. Oh, no, right.

It hasn't made forward progress from the prior high. And you're 100% right. So what do you have? Exactly what you said, an 18 18 months consolidation process that you just broke out of. And here's the issue. And I've been as negative as people know me as being positive. It just happened to be a long time ago in 2008.

But the bottom line is, when you look at how the market's breaking out, the bears said before it broke out, well, it can't break out because we're going into a recession and the Fed's going to have- It's only breaking out because of the Fed. Right. And it's low volume or they come up with excuses. So just to be tight, I got four reasons I'm still so bullish, right? Okay.

Four is good. Number one, the guys and gals printing the money told you they're going to keep printing money. Okay. What's two? Number two is the global economy is inflecting off of a historically weak level. If you look at the market PMIs and the breadth of the market PMIs, they are turning up off a historical level. I saw a thing actually in WSJ Daily Shot. I think they took a Deutsche Bank chart showing

European stocks that are missing earnings are rallying. I mean, what is that telling you? Right? All right, what else? Okay, so then you've got corporate credit and household credit are widely available. I mean, what is that telling you? Right? What else? Okay, so then you've got corporate credit and household credit are widely available. And that's important because of number four, the millennial demographic peak birth year is turning 30. And you may not notice Josh, but I'm a millennial, right?

I'm a 54 year old millennial. I haven't observed this. Right? And I'm a millennial because I only wanted experiences when I was 24 or 25. You were ahead of the game. You were ahead of the game. I was ahead of the game. Then I met my wife at 27, married 28, first son 29, second one on the way at 30, out to the burbs I went.

I even bought the minivan, which I still to this minute can't believe I did. The millennial demographic is just turning 30. How many people between 25 and 32 do you know getting married? To your point, sales of starter homes considered to be houses under $150,000 on fire this year. On fire. So that's household formation. This is the last one I want to throw at you.

Do you put any, well, let me ask it this way. One of the results of this time last year, so we had this 20% bear market or 19.8%, whatever you want to say, retail sales were horrible for the holiday season. They were, yeah. I really feel that we've built this economy on the consumer and the consumer's two biggest price signals are what they think their house is worth this week and what they know their portfolio, their 401k. Like that's what-

Yeah, for sure. These are the two biggest drivers in my opinion. Do you agree with that? I do. So if the stock market holds up- You got to add a third. Then retail sales should be good this Christmas. They should be.

I don't see a reason why they wouldn't. The third one that you got to add in there is do they have access to money, which goes into the home value, right? In other words words can you go to the bank and refinance your debt so we know statistically that they can right now they can and last year what i got wrong um we did expect a correction because typically when the fed is tightening rates you correct right it doesn't matter what quarter of the year you're in when they are excessive market corrects i didn't expect the worst quarter in the fourth quarter since the Great Depression.

None of us did. Right. So that got overplayed to the downside. Yes. And it affected sales because, honestly, I cut back spending. I mean, markets tank and I'm the bull. Yeah. Right? Like, not looking good. I'm trying to figure out what cardboard box I'm going to be in. It's only normal. Nobody spends more.

So now this year, to your point, you got full employment, you got open access to money, your household debt service ratios, which measures interest expense against income are at the cycle low. Like Josh, I come in every day trying to figure out where I'm wrong. My career risk is just being stupid wrong and giving people poor advice, right? And helping manage, you know, guys like you manage people's money. I look at every day, how am I going to be wrong? And the data that I'm finding today, I cannot find that it's wrong to expect further upside. You have full employment, open access to money, a turn in the global manufacturing off a historic low,

and a demographic tailwind we haven't had since the 90s. This game is on until the money shuts down. What we're watching is corporate credit, household credit, CDS, Globe, all this fun stuff that we watch. They're derivatives of the main thing. That's right. Even last December that wasn't dislocating, which is why I was so baffled by how much it went down. You heard it here first. Tony, how do people follow your stuff? At Tony Dwyer on Twitter. That's one.

And then more importantly, DwyerStrategy.com. DwyerStrategy.com. Okay. And they can get your thoughts on a regular basis? Yeah, we have market musings and our macro pieces. So there's a lot on there. You're the man. You come back?

I'll come back anytime, dude. Hey, thanks for watching. Go ahead and subscribe to the channel if you haven't already. Make sure you're following Tony on the Twitter. I'm back anytime, dude. Hey, thanks for watching. Go ahead and subscribe to the channel if you haven't already. Make sure you're following Tony on the Twitter. And by all means, leave us your comments. We love your feedback. Go ahead and smash that like button for me too, and we will be back soon.