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Trading in financial markets involves significant risk of loss which can exceed deposits and may not be suitable for all investors.
Before trading, please ensure that you fully understand the risks involved
Trading in financial markets involves significant risk of loss which can exceed deposits and may not be suitable for all investors. Before trading, please ensure that you fully understand the risks involved
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Wednesday, January 19, 2022

Busting Three Myths About SPX 500

Busting Three Myths About SPX 500
Busting Three Myths About SPX 500

* Trading in financial market carries risk and can result in loss of capital.
* This performance is only observed with historical backtests and not traded by the company.


The product and investment ideas do not consider the risk profile and financial position of the recipient and may not be suitable for everyone. Trading in financial markets and use of margin involves a significant risk of loss, which can exceed deposits. Please read the complete disclaimer carefully.

What are the myths?

The rate hike will kill the bull market.
Rising 10-year yields are bearish for SPX 500.
After a 25% rally in 2021, there will be a negative return in 2022 for SPX 500.

Let’s tackle each point one at a time:

Many market participants are worried about the Federal Reserve hiking interest rates for the first time in March 2022 since December 2015.

History suggests stocks could see more volatility after rate hikes, especially during the first three months, but this could be a function of the economy aging by the time hikes happen. An aging economy and bull market tend to see more significant moves. For example, the past seven cycles saw a correction in four of them during the next three months with an average loss of -4.2%. But Fed rate hikes by themselves don’t mean the bull market is approaching an end. Surprisingly, the previous seven cycles saw the S&P 500 Index higher 12 months after the first rate hike. Yes, some of those returns were muted, but by no means was this a bearish event for investors.

Performance of SPX 500 after the First Rate Hike

Date of First Rate Hike Returns in Next Three Months (%) Returns in Next Six Months (%) Returns in Next Twelve Months (%)
01/04/1987 19.1 20.9 1.5
11/05/1988 3.4 8.6 20.7
04/02/1994 -5.9 -2.5 2.4
25/03/1997 13.6 20.6 39.6
30/06/1999 -7.6 6.6 6.0
30/06/2004 -2.3 6.4 5.2
16/12/2015 -1.1 0.1 9.1

Second, the 10-year Treasury yield has risen sharply to begin the year, causing many high-flying tech companies to plummet. But is this negative news for all stocks? Higher yields usually indicate that the economy is expanding rather than slowing. As a result, cyclical equities do better when yields rise, lifting the index- quite the opposite from what people commonly perceive

As shown in the table below, markets witnessed an extended period of a higher 10-year Treasury yield the past six times; SPX-500 also rose. Some of those periods saw well over 30% gains in the following 12 months. The surge in yields could support a higher trending bull market, much different from most think.

SPX 500 returns during a surge in 10-year yields (periods of gains over 100 basis points have been considered)

Rising Interest Rates Start Date Rising Interest Rates End Date Duration (Months) Change in 10-Year Treasury Yield (%) Gain/Loss for SPX 500 (%)
26/12/1962 29/08/1966 44.7 1.7 18.3
16/03/1967 29/12/1969 34.0 3.6 1.3
23/03/1971 16/09/1975 54.6 3.2 -18.1
30/12/1976 30/09/1981 57.8 9.0 8.7
04/05/1983 30/05/1984 13.1 3.9 -7.9
29/08/1986 16/10/1987 13.8 3.3 11.8
15/10/1993 07/11/1994 12.9 2.9 -1.4
19/01/1996 08/07/1996 5.7 1.5 6.7
05/10/1998 21/01/2000 15.8 2.6 45.8
13/06/2003 28/06/2006 37.0 2.1 26.0
30/12/2008 05/04/2010 15.4 1.9 33.3
24/07/2012 31/12/2013 17.5 1.6 38.1
08/07/2016 05/10/2018 27.3 1.9 35.5
09/03/2020 31/03/2021 12.9 1.2 44.6
Average 25.9 2.9 17.3

Lastly, SPX 500 delivered a stellar return of 25% last year and is due for a correction. Well, data suggests otherwise - Years with greater than 25% return for SPX 500 are instead a good sign for the next year!

Just because stocks were up a great deal last year isn’t a reason to worry by itself. The truth is that significant annual gains are more likely to occur in larger bull markets, so there’s no need for investors to be concerned about a pullback based on what happened in 2021. The past seven times, the S&P 500 gained more than 25% in a year, saw the next year higher, with five of those years up double digits.

As shown in the table below, the S&P 500 is up roughly 12% on average and higher 86% of the time after gaining 25% the year before. There are many reasons to be concerned, but being bearish simply because stocks have rallied significantly, shouldn’t be one of them.

Year SPX 500 Return SPX 500 Next Year Return
1954 45.0 26.4
1955 26.4 2.6
1958 38.1 8.5
1975 31.5 19.1
1980 25.8 -9.7
1985 26.3 14.6
1989 27.3 -6.6
1991 26.3 4.5
1995 34.1 20.3
1997 31.0 26.7
1998 26.7 19.5
2003 26.4 9.0
2013 29.6 11.4
2019 28.9 16.3
2021 26.9 ?
Average return 11.6%
Past % Positive 85.7%

There are many things to worry about, but in the end, if the economy is still humming along and earnings are still strong, then equities could continue their uptrend. However, investors should be aware that midterm years typically see the most significant intra-year pullback, more than 17% on average for the SPX 500. So investors should be open to some correction this year. But the good news is if you are willing to hold, the index is up more than 32% on average a year off those lows.

Risks and Assumptions for Back-tested trading strategies
The risks and assumptions listed here are not intended to be an exhaustive summary of all the risks and assumptions involved.
The strategy might suffer from look-ahead bias which occurs due to the use of information or data in a study or simulation that would not have been known or available during the period being analyzed. This can lead to inaccurate results in the study or simulation.
Future price movements may not be exactly the same as the historical price movements and this could lead to variation in performance.
Testing can sometimes lead to over-optimization. This is a condition where performance results are tuned so high to the past they are no longer as accurate in the future.
The model assumes no slippages in trading. Slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed.
Drawdowns in actual trading can be higher than the tested system and losses could be significant in the event of leverage.
Unforeseen events can lead to variation in performance from the tested trading strategy.
The tested result has been computed with price feeds available from Bloomberg.
The testing environment has not considered transaction or any other costs.
Trading indicators used for the purpose of testing has been provided by Bloomberg.
The strategy might suffer from data mining fallacy, selection bias and backfill bias.

Data Source: Bloomberg
Data as of : 19/01/2022

Arun Leslie John
Chief Market Analyst

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