It seems like the odds favor a strong bounce to close the year if only to bring the December drawdown a little closer to historic norms. At least the timing would be right given deep oversold trading conditions. Of course, a “reversion to the mean” is not reason enough to expect a strong year-end rally.

To-date, the S&P 500 (SPY) is down 8.8% for the month of December. This drawdown rivals even this past October where the maximum drawdown of 9.4% on a closing basis was the third worst since 1951. If December ended today, it would exactly match the worst December since 1951 which was a 9.4% loss in 1980. The second and third worse Decembers were in 2008 and 1974. Note that just 4 years ago, December delivered a maximum drawdown of 4.6%, the 9th worst since 1951. The subsequent year (2015) was a very volatile year where the S&P 500 churned for over 7 months before suffering a “flash crash” and large sell-off before a bottom in early 2016. (Clearly my next exercise should be to quantify any significant correlations between poor Decembers and the performance of the following year!)

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Median and Average Maximum Drawdown on the S&P 500 By Month of the Year (January, 1950 to November, 2018)

This historic drawdown is also throwing up loud alarm signals for the “200DMA Signal.” I created the 200DMA Signal as a relative measure of the severity of a sell-off after the S&P 500’s 200DMA prints its first 5-day loss following an all-time high. This kind of turn has only happened 19 times since 1951; it is a surprisingly extreme kind of event. The last occurrence was on October 24th of this year. At that time, the S&P 500 was off its all-time high by 9.4%. The index is now down 13.1% from its all-time high. If the S&P 500 rallied its way to a new all-time high from this low, the “warning ratio” – the ratio of the drawdown at the time of the turn in the 200DMA and the ultimate closing low before the next all-time high, would be 0.72 (= 9.4/13.1). This ratio matches the 0.77 warning ratio from the last 200DMA Signal in August, 2015. 

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The latest 200DMA Signal triggered on 10/24/18.

The above table suggests that IF the S&P 500 does not hold a bottom here, then a much larger sell-off will be in play. Nine of the twelve 200DMA Signal episodes with worse (meaning lower) warning ratios delivered ultimate bottoms only after the S&P 500 dropped at least 20% from its all-time high. If this 200DMA Signal has meaning, then the odds are leaning heavily against the S&P 500 right now.

Starting last week, I discussed the possibility of a fresh wave of selling to start 2019. The 200DMA Signal indicates the risks are even higher than I thought just looking at the technical setups. The Federal Reserve’s task in the coming meeting on monetary policy is also even MORE difficult than I thought! 

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This weekly view of the S&P 500 (SPY) highlights the technical importance of this juncture for the S&P 500. The new 2018 closing low opens up the potential for a much larger sell-off, especially given the run-up to this topping pattern was so fast it created only weak “natural” support levels.