An S&P 500 three month thrust

Key Points

• Momentum is an important factor in the stock market
• The S&P 500 Index closed January with a 3-month gain of +15.5%
• In the last 70+ years, the market has shown a strong tendency to continue higher following thrusts of this magnitude

S&P 500 three months gain >= +15%

The S&P 500 closed January 2024 with a 3-month gain of +15.5%. Previous 3-month gains of 15% or more have tended to witness significant upside follow-through.

The table below displays all the months since 1955 when the S&P 500 registered a 3-month gain of +15% or more and subsequent S&P 500 performance. 

Note the high Win Rates - particularly for 3-months to 12-months - and the strong returns (12-month median return = +18%).

Given the new signal on 2024-01-31, does this mean "smooth sailing" for stocks in the year ahead? Not necessarily, but it does lend weight to the bullish side of the weight of the evidence ledger.

This signal as a trading model

It is not necessarily recommended that the indicator above be used as a standalone trading model. However, we will consider it as such to illustrate performance.

For our model, any new occurrence of a 3-month S&P 500 gain of +15% or more resets the counter to 12 months. For example, the signal on 2009-05-29 sets the counter to 12 months. The signal on 2009-06-30 resets the counter back to 12 months. So, barring any new signals, the holding period would be from 2009-05-29 through 2010-06-30 (i.e., 12 months after the last signal, or 13 months in total in this case).

To spell it out, the rules are simple:

• If the S&P 500 Index closes a month with a 3-month gain of +15% or more, buy the S&P 500 Index
• Hold the index fund for 12 months
• If a new signal occurs within those 12 months, extend the holding period another 12 months
• Sell the S&P 500 Index at the end of the holding period

The table below displays the S&P 500 performance using this model. The table shows the holding period length of each trade. Those with more than 12 months indicate that another signal occurred after the initial one.

The chart below displays the growth of $1 invested in the S&P 500 during the periods listed in the table above.

The table below summarizes S&P 500 performance during the periods shown above.

The results above are compelling, but it is important to remember that there is a difference between hypothetical backtests and actual trading. Note that the signal in March 1987 would have resulted in riding the 1987 decline and Crash all the way to the bottom (a -33.5% decline from peak to valley). So remember, there are no "magic" indicators - only weight of the evidence.

What the research tells us…

Thrust and momentum are essential factors in the stock market. Substantial gains often beget more gains as perceived market strength drives more investors to "take the plunge," and this new buying propels the market even higher. Since the 1950s, three-month gains of over +15% for the S&P 500 Index have typically been followed by additional gains in the year ahead. As 1987 proved, there are no guarantees despite a new favorable signal on the 2024-01-31 signal. But it does suggest continuing to give the bullish case the benefit of the doubt.