From 50/50 to 59/41 – Return of the animal spirits

The Hang Seng Index has risen 25% in 2017 and is now within 3.7% of the 2015 peak. The market had been strong but how much of an outlier is it? When we look at daily performance, we find the HSI had risen 59% of the time with an average gain/loss ratio of 1.29x, putting it in similar outlier territory as 2015 and 2007.


Until very recently, Hong Kong’s 2017 stock market rally had been one of the most stealthy bull market in recent memory. As of  1 August, the Hang Seng Index had risen 25% and at 27,540, the HSI is only 3.7% below the 2015 peak of 28,588 and 13.8% below the all-time high of 31,958 that was reached on 30 October 2007.

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3.7% away from 2015 peak, will the good times last?

As we approach the 2015 大時代 peak, we get the inevitable question about bubbles and whether we are due for a correction.

From a historical perspective, we can certainly appreciate where the concern is coming. In 2015, the Hang Seng Index had a blazing start, rising 21% by 28 April. Had the pace continued for the full year, it would have annualised to 63%. But the good times did not last. After peaking on April 28, the market corrected 23% the rest of the year and reversed the previous gains to a full year loss of 7.4%. Ouch.

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So, what are we to make of this year’s (2017) strong performance? Is it a repeat of 2015’s roller coaster ride or is the current rally likely to prove more sustainable?

Until today, my gut feel was that it may have more room to run. Why? First, I think the market’s animal spirits feeds on recent peaks. Until 2015’s 28,588 peak is surpassed, I suspect Mr. and Mrs Wong are still sceptical. From a behavioural perspective, others have commented that one sign of bubble is when taxi drivers start to give out stock tips and people quit their day jobs to day-trade.

I read somewhere that in the US market, the number of days that the market goes up and the times that the market goes down is roughly 50/50. Although the odds are roughly even, the reason why the markets have tended to go up is because average gains have outweigh average losses and the compound effect leads to long-term cumulative gains.

3,922 up days and 3,633 down days since 1986

I wanted to see if the same held true for the local stock market. Looking at the Hang Seng Index’s performance since 1986, although the market had risen 9.7x, the number of up days versus the number of down days is almost 50/50. Specifically, there were 3,922 up days and 3,633 down days. This is a ratio of 51.9%/48.1%. If one were to consider the average daily movements, the average up day gain was 1.09% while the average down day loss was 1.08%, so again very  close to 50/50.

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2017 has been an outlier – 59.4% Up Days and Gain/Loss ratio of 1.29

What about 2017? Well, in the 143 trading days this year, there has been 85 up days and 58 down days. This is a ratio of 59.4/40.6. Furthermore, when we consider the average daily movement, although the average gain on up days is only 0.57%, when this is compared against an average loss of 0.44% on down days, the gain/loss ratio of 1.29 is much higher the past five year’s average of 1.01.

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Current rally as much of an outlier as 2015 and 2007

Clearly, the 2017 rally had been strong but how does it compare to the previous “bubbles”. In the more recent memory, there was the 2015 大時代 rally. Through the first 78 trading days of 2015, the index rose 21%. Over those 78 trading days, there were 49 up days and only 29 down days. While 2015’s up days ratio of 63% is 4pp higher than 2017’s 59%, the average gain/loss ratio was milder at 1.19x (0.77% average gain versus -0.64% average loss).

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If one were to look further back, we saw an even more euphoric rally in 2007. Driven by hopes of a “through-train’ of China domestic investments, the Hang Seng Index had rallied by 60.7% through 30 October 2007 and reached an all-time intra-day high of 31,958. During this period, over the 204 trading days, the Hang Seng Index rose on 115 days and fell on 89 days. The Up days to Down days ratio was 56/44. Although this was milder than 2015’s 63/37 up/down days ratio, the longer duration of the cycle couple with an average gain/loss ratio of 1.20x helped to push the market up by 60%.

2017 less hot than 2005 and 2007

So if one were to consider the current market condition, we can see that 2017’s up days ratio of 59.4% is higher than 2007’s 56% but lower than 2015’s 63%. But from a daily percentage change ratio, 2017’s 1.29x ratio is higher than 2015’s 1.19x ad 2007’s 1.20x.

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In the long run, reversion to the mean is likely but timing is anyone’s guess

In the long run, a reversion to the man is probably inevitable and the up day to down day ratio should probably trend back towards 50/50. But as one can see in the table above, that up days ratio remained elevated in 2006 (59%) and 2007 (56%) and only reverted back to 47% in 2008.

Be that as it may, given the combination of higher than expect win streak and higher than normal win ratio, it might be better to simply ride the current wave than to initiate new buy positions at this stage. Caveat emptor.