The market is moving almost perfectly in line with seasonal patterns – the next rally after the midterms?

In a fully rational and efficient market, seasonal stock performance factors should be of no use to an investor, and perhaps not exist at all. A known historical market pattern would theoretically have to be chased by so much opportunistic and algorithmic money that it would be priced away and stop working. Still, there are plenty of people who are too skeptical to trust that they still seem to exert some influence on market movements. Let’s be clear, such skepticism is understandable. Estimating risk versus reward based on the month of the year or where we are in the presidential election feels like it’s without rigor, naive to all sorts of complications, relying on a small sample of recent years, blind to the current economic reality . Still, the calendar cadences aren’t completely useless. Over the course of a year, there is still a rhythm in liquidity flows, tax payments, business messages about the year ahead, as well as custom and superstition. Since 1928, of all days of the year, the three-month forward return was best on Oct. 25, according to Renaissance Macro. That was last Tuesday, when the tape started to look past horrendous results from Big Tech favorites Meta Platforms and Microsoft to push higher. The odds can be cut even smaller: October 28 through November 2 was the strongest five days of such a period through the year on average — an anomaly first brought to my attention many years ago by Larry McMillan of McMillan Analysis, which trades it through S&P 500 options. He modified it to show that the signal has an even better chance of working when there has been a drop of at least 3-4% in October (it was the case this year). Friday’s 2.5% jump gives this system a pretty good chance of coming through in 2022. More generally, it was tough going into September, being told it was the worst of all months for stocks in recent decades. The temptation to blur such a well-broadcast fact into the “what everyone knows isn’t worth knowing” spirit would have hurt. Last September was brutal, the S&P 500 fell 9.3%, trending downward toward the second half of the month, just as the seasonal script dictated. Known for its volatility and upward reversals, October has also complied, rushing to a new low in the bear market on October 13 before rising further to gains close to 9% to date. Positive Midterm Election Pattern So here we are, approaching Halloween, and the trend towards year-end strength is being reinforced by the widespread iteration of the turn of the midterm election. Since 1950, the S&P 500 has never fallen from November to April in a six-month period. And the index return 12 months after such an election, since 1960, has been over 20%, according to Citi. This has been true regardless of the party’s division of power. The gains in the months after “every by-election since 1950” sounds like it should be a lock. But this still equates to just 18 cases over that period, not exactly a huge statistical sample. As late as 2018, the fourth quarter of a half-year was a terrible one for stocks, which were bought back only by a mild turn of events by the Federal Reserve, which helped make a comeback in early 2019. In other ways, this year didn’t quite fit the historical pattern. Remember all the talk that stocks tend to rise up to and including the first rate hike by the Fed? This market peaked two months before ‘launch’. If a recession awaits in 2023, stocks will have peaked “too early” based on the 6-9 month average lead time. And if we’re not already in (or already out of) a recession, then the October 13 low would have been “too early” to be the last, as stocks historically never bottomed before a recession started. In fact, the only pattern left intact would be if there is no recession ahead and this is a nasty non-recession cyclical bear market, as we saw in 1962 with the Fed tightening and geopolitical shocks (Cuban Missile Crisis) in a midterm election year. As I like to say, seasonal effects are climate, not weather, which indicates broad trends, but doesn’t dictate how to dress for the elements at any given time. When it comes to the ongoing rebound rally, the seasonal lean is probably helping, but so is the fact that investor sentiment and positioning going into October were deeply pessimistic and defensive. In any case, the fact that the market has been in line with seasonal patterns is the absence of a negative – markets that defy broad trends (fail to recover if they are strongly oversold or fall on good economic news) reflect underlying weakness and can be insidious to be. The Bull Case In fact, as October set in, many bearish observers were pushing back against the idea that stocks would soon see relief from faded technical conditions and seasonal relief by going around the 2008 S&P 500 chart. 2022 pad fits pretty well. Of course, the market collapsed further in October 2008 on its way to a harrowing low in November (anticipating the eventual bottom of March 2009). With the current two-week gain of 12%, the index has now deviated sharply from its trajectory from 2008. Aside from the potential seasonal benefits now, the bull case could grip investors’ still defensive sentiment and under-exposure to equities, as well as the decline. of the tape to gain some downward momentum well below the June lows and the ability to recover from bad news (CPI report is called Oct. 13, huge technical profit shortfalls and stock declines last week). More importantly, this comes during a moment of easing from the upward spiral in bond yields, hinting that the Fed could slow its pace of tightening soon, with an earnings reporting season generally quite normal and not alarming (70% of companies beat lowered forecasts), and as economic data has not yet bent to the point that we have passed the tipping point into an impending recession. We’ve seen similar action before, as recently as the summer, keep in mind. A June-August S&P rally of 17% in hopes of a moderate Fed turn and a strengthening of macro data. That rally took the index as high as the 200-day moving average before flipping, with Fed officials then pushing markets back to tighten financial conditions again. The S&P’s current 200-day moving average is up about 5% from Friday’s close. A warning experience, for sure. At least this time around, the Fed is much closer to its supposed destination, some more valuation risk has flowed out of the largest index stocks, and of course this is the season when the market is often – but not always – tailwind.

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