S&P 500 up 27.5% – Why I think so

At the start of this year I was invited to a local financial analysis dinner in Charlotte, North Carolina. It was interesting listening to the key note speakers, one of whom was a former member of the Federal Reserve, talking about their outlooks for the market. It was a somber night full of gloom with no one believing that there could be any way to make money in any asset class for the foreseeable future.

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To understand the gloom, let's look at where the market was at that point in time. Many commentators were calling that the top was in and we were on our way down again. The chart certainly looks like we are heading down with successive lower tops.

At the end of the night, there was a competition for everyone to state how much they thought the S&P500 would rise or fall over the coming year with the person who was most accurate getting bragging rights next year. While many were putting in values starting with a minus, I put in 27.5%, that's 27.5% up! Let me explain why I thought (and still do think) that.

Reason #1

Don't follow the crowd. In nearly twenty years in the markets I have learnt that the more people who are singing from the same "hymn book", the less likely it is to come true. Being in that room confirmed to me that 2015 would most likely be a good year because everyone was so certain that it would be so bad.

Reason #2

Many people have different concepts on "True Value". For me I have always believed in the theory that Gold is the right measure of value. I recall having read a study that talked about the cost of goods in ancient times, comparing them to the costs now. It explained how for most goods, they cost the same now, in ounces of gold, as they did two thousand years ago! For that reason I always watch the Dow Jones in ounces of Gold. In the following chart the software allows me to change from USD to any other currency including Gold. So what i have is the Dow Jones priced in Gold.

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You can see that in gold value terms, we have been in a bear market from 1999 to 2011 (incidentally, that was 2 days off being exactly 12 years). "What about the bull market from 2002 to 2007?"; yes we had a share market that was going great in dollar terms, but you'll also remember that Gold was increasing too, and by a greater percentage. In "true value" we were losing value and did not even know it.

While I can talk about that at length (and will write a separate paper on that), the real focus for today is that since 2011 we have been in a sustained bull market. This time the Dollar and Gold charts are heading in the same direction thanks to a stable Gold price. To me, this is a sign of strength coming into the market.

Reason #3

In November 2014 we just finished building a new seasonality module for our software. It allowed me to view how stocks and commodities rise and fall during the year and see what the average movement was. Being curious, I shifted the focus to years of the decade so I could see how each year compared to the others. I was astounded with the result and this chart will show why:

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You can see that over the last 100 years, the 5th year of the decade has performed the best. What we are looking at is the average (actually Median). I've always been suspicious of averages, so I really want a way of seeing the variance of that average. In the following chart I changed the view to a Box and Whisker plot. Here, the line in the middle is our average, the box shows us the size of the first standard deviation and the whisker shows us the best and worst result for that interval.

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This confirmed to me that the 5th year of the decade was a very good year with the worst historical outcome a break-even year. Of course the average value is the final value at the end of the year and there is a lot of action that goes on in between that could wipe out a trading account. The software lets me "drill in" and examine what happened on average for each day of the year for each of the 5th year of the decade (you may need to re-read that).

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You can see that it starts off slow in January. From the 5th to the 30th March the average falls but after that it starts a long-term bull run. How does that compare to what we have done this year?

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We've had a 2.78% rise into March 5, the average is 4% to March 5. Although I did not have these last two months at the time.

All of this analysis was in my mind as I thought about what number I should put down. Of course 2015 could be the year that puts in a negative number, but all of the Technical and Quantitative analysis we do is based on probability, and I like the probabilities of this one.

Every good Trader/Analyst knows that an indicator does not guarantee a profitable trade, but if our analysis shows us that it has a higher probability, then we take the trade and place a stop in case we get it wrong. This is why we call them "Indicators" and not "Certainties".

We'll cover these concepts and more as we "kick-start" our education site (www.EducatedAnalyst.com) back into life. Make sure you check it out and subscribe as we, and our partners, provide you with information that we hope you come to see as invaluable in your trading life.