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LEARNING FROM HISTORICAL MARKET FACTS
When investors are concerned about future economic outcomes, they often
migrate toward more defensive-oriented long-term U.S. Treasury bonds (TLT).
The recent surge in demand for defensive bonds caused an extremely rare and
extended look on the monthly, weekly, and daily charts of TLT. TLT closed
above the upper Bollinger Band on all three charts (monthly. weekly, daily)
on May 31, 2019. Therefore, it might be helpful to know the following: (a)
how many times has this occurred in the past, (b) what happened over the next
two years in the bond and stock markets, and (c) historically, after such a
rare extended bond market condition, which major asset class provided the
better risk-reward profile in the historical cases?
Since finding simultaneous monthly, weekly, and daily closes above the
upper Bollinger Band for TLT was so rare, we also performed similar
studies to better understand historical tendencies in cases with larger and
more meaningful sample sizes. Thus, we addressed the questions above
by studying three data sets (n = 10, n = 18, and n = 51).
STUDY ONE: MONTHLY, WEEKLY, AND DAILY
The first case is extremely rare. Since TLT historical data is limited, we
also used VUSTX as a proxy for TLT. Data for VUSTX dates back to 1986. Thus,
all three studies cover data going back to 1986. We examined data for
approximately 8,349 trading days, assuming a typical year has 253 sessions.
You can make an argument that pushing TLT above the upper Bollinger Band
on monthly, weekly, and daily charts speaks to a somewhat overextended
market, especially from a short-term perspective. How did bonds perform
following such a rare extended condition? Over the next 90 days, the extended
market tended to take a break, posting negative average and median returns.
How many trading days featured simultaneous monthly, weekly, and daily
TLT/VUSTX closes above the upper Bollinger Band? The answer is 10 trading
days. What happened next in the bond market?
How did the stock market perform after bonds hit an extremely rare and
extended trifecta? Historically, quite a bit better than bonds. Rather than
posting negative average and median returns looking out 90 days, stocks
posted green figures.
It is also important to note, the expectancy for stocks over the following
30 days to 2 years was quite a bit more attractive than the expectancy for
bonds. For example, over the next 90 days bonds were
only green in 50% of the cases and the average loss was 0.35%, which is quite
a bit less attractive than stocks that saw 70% green outcomes with an average
gain of 4.75%. Over the next 60 days, stocks beat bonds by an average of
7.37%, which intuitively passes the supply and demand common sense test,
given the rare one-side nature of an extended bond market.
STUDY TWO: MONTHLY AND WEEKLY
In order to get our sample size up and allow us to look at tendencies, we
examined historical cases that posted TLT/VUSTX closes above both the monthly
and weekly upper Bollinger Band. Dropping the daily requirement brought the
historical cases up to 18. The results were very similar; the average and
median outcome clearly favored stocks over bonds. Over the next 180
days, stocks beat bonds by an average of 10.43%.
STUDY THREE: MONTHLY
Since TLT closed above the upper monthly Bollinger Band on May 31, 2019,
we can still learn something by examining similar monthly closes in TLT/VUSTX
history. The less restrictive criteria brings the number of historical cases
to 51. Once again, the results are similar; average and median outcomes,
along with the percent of positive outcomes, clearly favored stocks over
bonds looking out between 30 days and 2 years.
Over the next 180 days, stocks beat bonds by an average of 7.15%,
with 80% of stock cases resulting in green figures; bonds only posted green
results in 57% of the cases.
RARE FUNDAMENTAL ISSUES NOT UNIQUE TO 2019
The trade war and tariffs are legitimate concerns in 2019. However, every
historical case cited featured a unique set of fundamental and technical
concerns; otherwise, the bond market would not have reached such a rare and
extended state.
DOES ANY OTHER EVIDENCE ALIGN WITH THE EXTENDED BOND MARKET?
Given the recent pullback in stocks and negative trade developments, this
week’s video updates numerous “this just happened in 2019” studies. The video
also looks at the bond and stock markets from additional perspectives.
2019 WILL FOLLOW A UNIQUE PATH
Each year is unique and 2019 will follow its own path.
TARIFFS ARE A LEGITIMATE ECONOMIC CONCERN
The longer the President’s tariffs remain in place, the higher the odds it
will lead to economic damage and weakness. Thus, the markets are going to
want to see some progress relative to moving closer to the negotiation table,
something that has little to do with the historical cases above. However, in
the average historical case, the rare and concerning fundamental issues of
the day tended to be addressed in some way. How do we know that? Stocks
tended to beat bonds after bonds reached a rare and extended state.
PRESENT DAY DATA GOVERNS DECISIONS
Our decisions in 2019 will continue to be governed by present day facts.
The historical studies simply give us factual and unbiased reference points
to better understand the present day probabilities. Probabilities speak to
uncertainties and a wide range of possible outcomes.
This post is written for clients of Ciovacco Capital Management and
describes our approach in generic terms. It is provided to assist clients
with basic concepts, rather than specific strategies or levels. The same terms of use
disclaimers used in our weekly videos apply to all Short Takes
posts and tweets on the CCM Twitter Feed, including the text and images
above.
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