Long term trend of the UK market

Posted on 21 November 2016 by Almanacist

What can the very long term tell us about the trend of the UK market?

[This is an update of an article that first appeared in April 2013.]

1946-2016

The chart below plots the FTSE All Share Index from 1946 to the present day.

The Y-scale is logarithmic, which presents percentage (rather than absolute) changes better over long periods, and so is more suitable for long-term charts.
The straight line is a line of best fit calculated by regression analysis.

Observations–

The R² for the line of best fit is 0.96, which is impressively high for such a simple model (i.e. the line of best fit fairly accurately approximates the real data points).
The FTSE All Share Index fluctuated closely around the trend line (line of best fit) from 1946 to 1973; it then traded consistently below the trend line until 1983, when it crossed over to trade above the trend line until 2001. From 2001 the Index was close to the trend, but then in 2008 fell significantly below it and has yet to revert to the long-term trend line.

Forecasts

The equation of the line of best fit in the chart above (with a little more precision) is-

y = 0. 846531e^0.000207x

This equation allows us to make forecasts for the FTSE All Share Index. It is, in effect, the Holy Grail, the key to the stock market – as simple as that!

For example, at the time of writing the FTSE All Share Index is 3664 while the above equation forecasts a value today (according to the long-term trend line) of 5878. This suggests the index is currently under-priced relative to the long-term trend line. But as can be seen in the above chart the index can spend long periods trading above or below the long-term trend line.

Now, if we think that the trend of the market in the last 70 years will broadly continue, then we can use the equation to forecast the level of the FTSE All Share Index in the future. And this is what has been done in the following table. Equivalent forecasts for the FTSE 100 Index have also been given.

Date	FTAS Forecast	FTSE 100 Forecast	Chng(%)
Dec 2017	6,403	11,762	75
Dec 2020	8,036	14,761	119
Dec 2030	17,128	31,460	367
Dec 2040	36,513	67,068	897

The equation says that the trend line value for FTSE 100 at the end 2017 will be 11,762 (75% above its level in November 2016,).

By end 2020 the forecast is for a FTSE 100 level of 14,761 (+119%), and by end 2040 the equation forecasts a FTSE 100 trend value of 67,068 (+897%).

So, that’s easy.

Well, except this…

1920-2016

We will now look at a trend line calculated from data 1920 to 2016.

First, here is the chart from 1920 with its trend line.

In this case, the R2 is 0.69, quite a bit lower than than the data from 1946 (i.e. the calculated trend line is not such such a good fit for the actual data).

Again we can use the equation of the trend line to forecast trend values for future dates.

Date	FTAS Forecast	FTSE 100 Forecast	Chng(%)
Dec 2017	4,116	7,652	14
Dec 2020	5,006	9,195	37
Dec 2030	9,230	16,953	152
Dec 2040	17,020	31,263	365

Whereas for the data from 1946 forecast a FTSE 100 level of 11,762 at end of 2017, the 1920 data forecasts a level of 7,652 (14% above the current level).

As can be seen above, the trend-line equation is very sensitive to the sample data (i.e. in this case, the choice of start date).

So, which trend do you prefer, that from 1920 or from 1946?

The above is partly an extract from the new 2017 edition of The Harriman Stock Market Almanac.

Order your copy now!

January Barometer

Posted on 26 January 2016 by Almanacist

The January Barometer holds that the direction of the market in January predicts the direction of the market for the whole year. The saying is:

“as January goes, so goes the year”

The January barometer was first mentioned by Yale Hirsch of the Stock Trader’s Almanac in 1972.

NB. The January Barometer is sometimes confused with the January Effect (more on this confusion here).

So, does the January Barometer work?

According to John Dorfman in an article in January 2016

the barometer has been correct in 38 of the past 54 years for a success rate of 70 percent.

70% accuracy is not bad. Although Dorfman does point out that this under-performs a naive model (which forecasts the market will be up every year) which has an accuracy of 74% over the same period.

How does the January Barometer fair in the UK market?

Let’s jump straight in with a long-term view. The following chart plots the January and same-year full-year returns for the FTSE All-Share Index since 1800.

To support the January Barometer there needs to be a majority of points in the top-right and bottom-left sectors (i.e. both positive returns for January and the full year, or both negative for January and the full year). And, yes, broadly that does seem to be the case. The line of best fit has a positive slope which agrees with our visual inspection. The correlation (R2) is very low, but to be fair the January Barometer does not claim there is a close correlation in (January and full-year) returns, just that the sign (i.e. the direction) is the same.

We’ll now look at a shorter period to see how the relationship changes over time.

The following chart is as above except the time period is from 1900 to the present day.

Since 1900 the relationship has remained largely the same, i.e. the January Barometer broadly holds.

Finally, we look at the (relatively) short-term; the chart below shows the relationship since 1980.

And, again, the January Barometer still seems to have worked since 1980.

The following table summarises the success rate of the January Barometer over the three time periods. For example, since 1800, the Barometer has been correct for 61% of years.

The table also includes figures for the success rate for years in which the returns in January were respectively positive and negative. For example, since 1800 the Barometer was correct for 65% of years in which the market rose in January.

	Jan (all)	Jan (up)	Jan (down)
1800-2015	61%	65%	55%
1900-2015	66%	69%	60%
1980-2015	72%	87%	46%

As can be seen, for all three periods the Barometer had success rates of over 50% for all years – and so can be considered to have worked. Since 1980 the Barometer has been notably successful.

But there can be seen a difference in accuracy between years in which January returns were positive or negative. The Barometer works better in years with positive returns.

The January Barometer since 1980

The following chart might help to visualise the behaviour of the Barometer in recent years. The chart plots the performance of the Barometer for each year from 1980; a 1 is plotted for years in which the Barometer worked, and a -1 in those years when it didn’t.

Of late the performance has been patchy, but there was a remarkable run of 12 years from 1982 in which the Barometer worked every year. It should be noted perhaps that the market was strong in this period: annual returns were positive for every year except one year. And, as we saw above, the Barometer does seem to work better in years when the market rises.

Economic significance

So, is the January Barometer economically significant – i.e. can you trade it profitably?

The following chart plots the FTSE All-Share returns for January and the full-year for the period 1980-2015.

A concern might be that a significant portion of the full-year returns might be accounted for by the month of January itself. In other words, by the time one acts on a signal from the Barometer, the market has already moved significantly. However, the chart shows that although a disproportionate size of the full year return have been accounted for in January, the remaining returns are significant.

Over this 1980-2015 period, if a strategy had invested in the market from February to year-end just in the years that the Barometer gave a signal for a positive market, the average annual return in those years would have been 9.5%. This is marginally better than the average market return for all years over the same period of 9.0%.

Conclusion

The January Barometer has had a better than 50% success rate for the three periods studied here: 1800, 1900, and 1980 to the present day.

Although one should be wary about assigning a special relationship between January and the full-year. For example, since 1800 the month of February has been almost as good as January in predicting full year returns, and since 1900 February has had a higher succes rate in positive return years.

Market behaviour around the turn of the month

Posted on 16 May 2014 by Almanacist

The Almanac has already covered the market behaviour on the first and last trading days of the month; this study widens the analysis to look at the behaviour of the market on the 10 days around the turn of the month (TOM).

The days studied are the 5 last trading days of the month, from ToM(-5) to ToM(-1) (the latter being the last trading day of the month), and the first 5 trading days of the following month, from ToM(+1) to ToM(+5). The index used is the FTSE All Share.

From 1970

The charts below analyse the 532 TOMs since 1970. The first chart shows the average daily return for the index on the 10 respective days. The second chart shows the proportion of positive returns on those days.

For example, on ToM(-5) the market has on average risen 49.6% of the time with an average return of -0.03%.

We can see that there is a definite trend for the market to be weak at the beginning of the 10-day period, to then strengthen around the turn of the month, and afterwards to weaken again.

Does this behaviour persist in more recent years?

From 2000

The charts below are the same configuration as above, except they look at the shorter time period: the 172 ToMs since the year 2000 to 2014.

Broadly, the behaviour has been similar for the last few years as that from 1970. The main observation is that the strength of the first trading day of the month, ToM(+1), has become ever more pronounced. On average the market has risen 66% of all ToM(+1) with an average change of 0.31% (which is ten times the average change on all trading days).

Reference – papers on Turn of the Month

[Papers listed in reverse date order]

Brief descriptions of the FTSE UK indices

Posted on 17 April 2014 by Almanacist

A brief overview of the range of indices that FTSE International (FTSE) have created to measure the equity markets in the UK.

FT Ordinary Share Index (FT30)

The FT30 Index was first calculated in 1935 by the Financial Times newspaper. The Index started at a base level of 100, and was calculated from a subjective collection of 30 major companies – which in the early years were concentrated in the industrial and retailing sectors.

For a long time the Index was the best known performance measure of the UK stock market. But the index become less representative of the whole market. Also the index was price-weighted (like the DJIA), and not market-capitalisation-weighted. Although the index was calculated every hour, the increasing sophistication of the market needed an index calculated every minute and so the FT30 has been usurped by the FTSE 100.

Articles on the FT30 Index.

FTSE 100

Today, the FTSE 100 Index (sometimes called the “footsie”) is the best known index tracking the performance of the UK market. The index comprises 100 of the top capitalised stocks listed on the LSE, and represents approximately 80% of the total market (by capitalisation). It is market capitalisation weighted and the composition of the index is reviewed every three months. The FTSE 100 is commonly used as the basis for investment funds and derivatives. The index was first calculated on 3 January 1984 with a base value of 1000.

The FTSE 100 Index, and all the FTSE indices, are calculated by FTSE International – which started life as a joint venture between the Financial Times newspaper and the London Stock Exchange, but is now wholly owned by the LSE.

Articles on the FTSE 100 Index.

FTSE 250

Similar in construction to the FTSE100, except this index comprises the next 250 highest capitalised stocks listed on the LSE after the top 100. The index is sometimes referred to as the index of “mid-cap” stocks, and comprises approximately 18% of the total market capitalisation.

Articles on the FTSE 250 Index.

FTSE 350

The FTSE 350 is simply an index comprising all the stocks in the FTSE 100 and FTSE 250 indices.

Articles on FTSE 350 Index.

FTSE Small Cap

Comprised of companies with a market capitalisation below the FTSE 250, but above a fixed limit. This lower limit is periodically reviewed. Consequently the FTSE Small Cap Index does not have a fixed number of constituents. In mid-2012, there were 248 companies in the index, which represented about 2% of the total market by capitalisation.

Articles on FTSE Small Cap Index.

FTSE All-Share

The FTSE All-Share is the aggregation of the FTSE 100, FTSE 250 and FTSE Small Cap indices. Effectively all those LSE listed companies with a market capitalisation above the lower limit for inclusion in the FTSE Small Cap Index. The FTSE All-Share Index is the standard benchmark for measuring the performance of the broad UK market and represents 98-99% of the UK market capitalisation.

Articles on the FTSE All Share Index.

FTSE Fledgling

This index comprises the companies that do not meet the minimum size requirement of the FTSE Small Cap Index and are therefore outside of the FTSE All-Share Index. In mid-2012 there were 112 companies in the FTSE Fledgling Index.

Articles on FTSE Fledgling Index.

FTSE All-Small Index

This consists of all the companies in the FTSE Small Cap and FTSE Fledgling indices.

FTSE TMT

Reflects the performance of companies in the Technology, Media and Telecommunications sectors.

FTSE techMARK All-Share

An index of all companies included in the LSE’s techMARK sector.

FTSE techMARK 100

The top 100 companies of the FTSE techMARK All-Share, under £4bn by full market capitalisation.

FTSE AIM UK 50 Index

Comprises the 50 largest UK companies quoted on the Alternative Investment Market (AIM).

FTSE AIM 100 Index

Comprises the 100 largest companies quoted on the Alternative Investment Market (AIM).

FTSE AIM All-Share Index

All AIM-quoted companies.

The Stock Market in December

Posted on 2 December 2013 by Almanacist

December is the strongest month for the stock market – the lesson from history for investors is don’t be out of the market in this month. Since 1984 (when the FTSE 100 Index was created), the index has increased on average by 2.5% in December. In fact, in the 28 years since 1984 the market has only fallen four times in December – the last time in 2002.

The accompanying chart plots the percentage performance of the FTSE All Share Index for each December since 1982. For example, last year in 2012 the market rose 0.9% in December.

It is interesting to note that the extraordinary strength of shares in this month (sometimes called the December Effect) is not limited to the UK. An academic paper published in 2013 showed the results of analysis on stock markets in 70 countries; it was found that across these 70 stock markets December was the strongest month (with an average return of 3.1%), and out of the 70 countries 65 have positive returns in December.

On average in December the market rises very gently in the first two weeks, and then roars away in the second half of the month – which is the strongest two-week period in the whole year for the market. Further, historically the two strongest days in the whole year for the market have been 24 and 27 December.

Sectors

In the last twenty years the sectors that have been strong in December have been: Construction & Materials, Life Insurance, Support Services and Travel & Leisure; while the weak sectors have been: Banks, General Retailers, and Pharmaceuticals & Biotechnology.

For companies, the following FTSE 350 shares have performed well in December over the last ten years: William Hill, Balfour Beatty, JPMorgan Emerging Markets Inv Trust, Witan Investment Trust and Alliance Trust; the shares of these companies have risen every December for the past ten years. The shares that don’t seem to like December are: Centamin, Rank Group and Amlin.

December is a very quiet month for company results: only three FTSE 100 companies release their prelims (finals) and there are no interims.

Diary

Dates to watch this month are: 4 Dec – MPC interest rate announcement at 12 noon (anticipated), 5 Dec – US Nonfarm payroll report (anticipated), 10 Dec – FTSE 100 Index quarterly review, 19 Dec – Triple Witching. The London Stock Exchange will be closed 25th and 26th and will close early at 12h30 on the 31st.

Article first appeared in Money Observer

Further articles on December.

The Stock Market in November

Posted on 1 November 2013 by Almanacist

Since 1984 the FTSE 100 Index has risen in 59% of years in November, with an average return over the period of 0.7%. This gives it a rank of 6th place for monthly performance. Although this performance is only average, the significant feature of November is that it marks the start of the six-month strong half of the year (November to April). In other words, investors should be increasing exposure to the market this month (if they haven’t already done so in October).

The accompanying chart plots the percentage performance of the FTSE All Share Index for each November since 1982. For example, last year in 2012 the market rose 1.4% in November.

On average the market tends to rise the first three days of the month, then to given up those gains over the following few days, rise again and fall back, until finally increasing quite strongly over the final seven trading days of the month. It could be noted in passing that November holds the record for the greatest ever one-day increase in the FTSE 100 Index: on 24 November 2008 the index rose 9.8%!

Sectors

In the last twenty years the sectors that have been strong in November have been: Beverages, Electronic & Electrical Equipment, Fixed Line Telecommunications, Food Producers, Life Insurance, Media, Mining, Technology Hardware & Equipment and Travel & Leisure. While the weak sectors have been: Aerospace & Defense, Banks, General Industrials, Oil & Gas Producers and Real Estate Investment Trusts.

For stocks, the following companies have performed well in November over the last ten years: Babcock International Group, Compass Group, Premier Farnell, Shire and Tate & Lyle. The shares that don’t seem to like November are: AstraZeneca, Greggs, Herald Investment Trust, Rentokil Initial and Tullett Prebon.

Pairs trade

An interesting strategy to consider in November is to pairs trade Shell and Exxon. Since 2000 Shell shares have out-performed those of Exxon (priced in sterling) in November by an average 3.7 percentage points. The strategy would be to go long of Shell and short of Exxon the end of October and close the positions the end of November.

November is the third busiest month for interim results analysis: 62 companies from the FTSE 350 make their announcements this month.

Diary

The only significant economics date this month is the MPC interest rate announcement on 6 November; and there will be a MSCI quarterly index review announcement on the 12th.

Article first appeared in Money Observer

1946-2016

Observations–

Forecasts

1920-2016

How does the January Barometer fair in the UK market?

The January Barometer since 1980

Economic significance

Conclusion

Observations

From 1970

From 2000

Reference – papers on Turn of the Month

FT Ordinary Share Index (FT30)

FTSE 100

FTSE 250

FTSE 350

FTSE Small Cap

FTSE All-Share

FTSE Fledgling

FTSE All-Small Index

FTSE TMT

FTSE techMARK All-Share

FTSE techMARK 100

FTSE AIM UK 50 Index

FTSE AIM 100 Index

FTSE AIM All-Share Index

See also

Sectors

Shares

Diary

Sectors

Shares

Pairs trade

Diary