Buyer Exhaustion?

The Fat Pitch, April 25, 2013

Let's place the current rally in perspective to determine whether it is unusual or extreme.

Key points:

• SPX is likely to close higher every month from November through April for the first time in 15 years. It's only the third such streak since 1980.
• The current rally has gone up by a larger percentage than two-thirds of the multi-month rallies of the past 13 years.  With only one exception, its the biggest rally that didn't start at a major bottom (like 2009).
• 2013 is the first time in 17 years that there hasn't been even a 5% retrace by May.
• The gain over the past 6 months is 4 times greater than the average annual gain in SPX.

November-April all up: The rally started in November and has run 23 weeks. It has been up every month since, without a retrace. If SPX closes April above 1569, it will be the first time since 1998 that SPX has been up every month from November through April.

Since 1980, this has happened only 3 times. In other words, it's a once a decade occurrence. 90% of the time, at least one of these months will be down.

We've highlighted those 3 occurrences plus one other in the chart below.

Two things you'll notice is that in each case, SPX generally lost at least 7% over the following months but the longer term trend remained higher.

• In 1982-83, SPX was up from August to April; from the May open the July low, it lost 9%. 
• In 1995-96, SPX was up from November to June; from the May open to the July low, it lost 7%.
• In 1997-98, SPX was up from November to April; in July and August, it lost 20%. 
• In 1985-86, SPX was up from October to March. From the end of May to the September low, it lost 8%.

Percentage gain: Next, let's look at the gain in SPX during this rally. 

From low to high, SPX has gained 19% in the past 6 months. The average annual gain in SPX since 1980 is 9.5%, so the current rally is outperforming by four times. 

We've shown all the multi-month rallies of more than 5% since 2000 in the chart below. The percentages show the gain; the red shading shows the corrections (the width is equal to 3 months). The blue shading is the Flash Crash.

There have been 12 multi-month rallies since 2000; the current rally is the 13th. The average gain is 18% with a median gain of 17%. The current rally (19%) is larger than two-thirds of these. If it extends past SPX 1625, it will be longer than all but two. Bear in mind that we are only considering the biggest rallies, not all rallies. This one is exceptional even among the elite.

What makes this rally even more unusual is when it is occurring. Strong rallies after a steep fall (2003, 2009 and 2011) are the norm. But a strong rally like this is really only comparable to the one in 2006-07, which rose 21% before falling 7% over the next month. If SPX repeats that pattern, it will rise to 1625 and then fall to 1510. The good news is it rose another 15% later in 2007. The rest, of course, is history.

Year-to-date: Readers of this blog will recall that SPX has a strong tendency to correct at least 5% before the first week in April. Since 1980, a 5% correction has taken place before before the first week in April 85% of the time. That hasn't happened this year. In fact, this will be the first time it hasn't happened by May in 17 years (1996). It is, in other words, a very unusual start to the year. Read further here. 

Strength of the rally: Another way to measure the strength of the rally is compare the gain over a period of time. We can easily do that by looking at the difference between two moving averages; a powerful rally will create a wide spread in the averages.

The chart below looks at the difference between the 13 and 34-ema over the past 15 years. The vertical lines show the other times when the rally was as strong as this one.

The message from this chart is similar to that from the other charts above. There is a pattern of buyer exhaustion that ensues over the following months, with the indices either moving sideways for a several months (1998, 2004, 2011) or severely correcting (2007, 2010, 2012).