The market is moving in-line with seasonal patterns almost perfectly — Post-midterms rally next?
In a fully rational and efficient market, seasonal stock-performance factors should be of no use to an investor, and perhaps should not exist at all. A well-known historical market pattern should, in theory, be chased by so much opportunistic and algorithmic money that it would be priced away and stop working. Yet enough people are too skeptical to rely on them that they seem to still exert some sway over market moves. Let’s be clear, such skepticism is understandable. Gauging risk-vs.-reward based on the month of the year or where we are in the presidential-election cycle feels as if it’s without rigor, naïve to assorted complications, reliant on a smallish sample of past years, blind to current economic realities. Yet the calendar cadences aren’t quite useless. Over the course of a year, there is still a rhythm to liquidity flows, tax payments, corporate messaging about the year to come, as well as habit and superstition. Since 1928, of all days of the year, the forward three-month return has been the best on Oct. 25, according to Renaissance Macro. That was last Tuesday, when the tape began looking past awful results from Big Tech favorites Meta Platforms and Microsoft to push higher. The probabilities can be carved even thinner: Oct. 28 through Nov. 2 have been the strongest five days, on average, of any such patch of time through the year — an anomaly first brought to my attention many years ago by Larry McMillan of McMillan Analysis, who trades this through S & P 500 options. He has modified it to show that the signal has even better odds of working when there has been at least a 3-4% pullback during October (there was this year). Friday’s 2.5% jump gives this system a pretty good shot of coming through in 2022. More broadly, entering September it was hard to avoid being told it has been the worst of all months for stocks over the decades. The temptation to fade such a well-broadcast fact in the spirit of “what everyone knows isn’t worth knowing” would have hurt. This past September was brutal, the S & P 500 down 9.3%, with the downside skewed toward the second half of the month, just as the seasonal script dictated. October, known for volatility as well as bear-goring upside reversals, has complied as well, rushing to a fresh bear-market low on Oct. 13 before ripping higher to a near-9% gain so far. Positive midterm election pattern So here we are, approaching Halloween, and the tendency for late-year strength is being amplified by widespread repetition of the midterm election-year twist. Since 1950, the S & P 500 has never been down from November to April in a midterm year. And the 12-month index return following such an election, since 1960, has exceeded 20%, according to Citi. This has been true regardless of the party power split. Gains in the months following “every midterm election since 1950” sounds like it must be a lock. But this still amounts to only 18 instances over that span, not exactly a vast statistical sample. As recently as 2018, the fourth quarter of a midterm year was awful for stocks, redeemed only by a dovish turn by the Federal Reserve that helped drive a comeback in early 2019. In other ways, this year has not quite fit the historical template. Remember all the talk that stocks have tended to rally up to and through the first Fed rate hike? This market peaked two months ahead of “liftoff.” If a recession awaits in 2023, then stocks will have peaked “too early” based on the 6-9 month average lead time. And if we’re not yet in (or already out of) a recession, then the Oct. 13 low would have been “too soon” to be the final one, as stocks in the past have never bottomed before a recession started. In fact, the only such pattern still intact would be if there is no recession on the horizon 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, indicating broad tendencies but not dictating how to dress for the elements at any given moment. When it comes to the ongoing rebound rally, the seasonal tilt is probably helping but so is the fact that investor sentiment and positioning entering October was profoundly pessimistic and defensive. The fact that the market has been in tune with the seasonal patterns is at least the absence of a negative – markets that defy broad tendencies (failing to rally when deeply oversold or falling on good economic news) reflect underlying weakness and can be treacherous. The bull case In fact, entering October, many bearish observers were pushing back against the idea stocks should soon get relief due to washed-out technical conditions and seasonal relief by passing around the S & P 500 chart from 2008. To that point, the 2022 path fit reasonably well. Of course, the market collapsed further in October 2008 on the way to a harrowing November low (ahead of the ultimate March 2009 bottom). With the current two-week 12% ramp, the index has now diverged sharply from the 2008 trajectory. Beyond the potential seasonal advantages now, the bull case can grab on to still-defensive sentiment and investor under-exposure to stocks, as well as the tape’s refusal to get any downside momentum much beneath the June lows and ability to rally on bad news (hot CPI report Oct. 13, massive tech-earnings shortfalls and stock declines last week). This is happening, importantly, during a moment of relief from the upward spiral in bond yields, with a hint the Fed might slow its tightening pace soon, with earnings-reporting season on the whole pretty normal and not alarming (70% of companies beating reduced forecasts), and as the economic data have not yet buckled in a way that says we have passed the tipping point into imminent recession. We’ve seen similar action before, as recently as the summer, keep in mind. A 17% S & P rally from June-August on hopes of a dovish turn by the Fed and a firming in macro data. That rally took the index right up to the 200-day moving average before rolling over, with Fed officials then pushing back on markets to re-tighten financial conditions. The S & P’s current 200-day average is up about 5% from Friday’s close A cautionary experience, for sure. This time, at least, the Fed is that much closer to its assumed destination, a bit more valuation risk has bled out of the largest index stocks, and, naturally, ’tis the season when the market often – but not always – catches a tailwind.