Stocks are repeating an extremely bullish pattern: Morning Brief

Mon, Dec 23, 2019, 4:21 AM

The last three times this happened, stocks rose at least 30%

Stocks finished the last full trading week of the year at record highs.

Since the most recent trough in the market hit back in early October, the S&P 500 is up 11% and the Dow has gained just under 9%.

This rally has certainly caught the attention of investors.

According to the American Association of Individual Investors, 44.1% of investors were feeling bullish for the week ended December 18, up 6.5 percentage points from the prior week and the highest reading of 2019. And a report from Bank of America Global Research earlier this week showed the firm’s clients were net buyers of stocks for the third week in a row.

The newfound enthusiasm for stocks into the end of the year will certainly make some observers nervous, as this bullishness will be seen as a contrarian indicator of what the future holds for this market.

But taking a step back from the market’s recent rally and investors concerned about the November-December push to record highs should find some relative comfort from market history. After all, a major theme earlier this year is that the market had “gone nowhere” for almost two years.

In a note to clients this week, Fundstrat’s Tom Lee highlighted periods similar to the flat, frustrating market of 2018-19. A period during which investors endured a nearly 20% decline while stocks gained a measly 5% during a 20-month period that saw corporate earnings rise in excess of 20%. (Of course, history also shows the market’s performance doesn’t always square with current-year earnings.)

Regular readers of Tom Lee’s work will not be surprised: history says this current set up is quite bullish.

After long periods of "going nowhere," the next two years tend to be quite strong for the stock market. (Source: Fundstrat)

Lee looked at periods from the 1950s, 1980s, and earlier in the 2010s and found that when the market goes up 5% or less over a 20-month period, returns in the two years ahead tend to be stellar. Taking a composite of these periods implies a 53% return for the S&P 500 over these periods that follow flat markets.

And this points towards returns that could top 25% for the S&P 500 in 2020. With 2020 potentially serving as the mere beginning of this new breakout rally.

History suggests that 2020 could be a breakout year with stocks rising more than 25% again. (Source: Fundstrat)

Last week, we highlighted work from SunTrust’s Keith Lerner that showed strong markets often beget more strength in the year ahead.

Since World War II, the S&P 500 has gained more than 20% in a year 24 times; the following year, stocks finished higher 79% of the time (or 19 times) with the average gain totaling 13%. In 16 of those 19 years, the market gained double-digits.