In a perfectly rational and efficient market, seasonal factors of stock market performance should be of no use to an investor, and perhaps should not even exist at all. A well-known historical market pattern should, in theory, be driven by so much opportunistic and algorithmic money that it would be priced in and stop working. Yet, enough people are too skeptical to trust it and still seem to exert some influence on market movements. Let’s be clear, such skepticism is understandable. Assessing risk versus reward based on month of the year or where we are in the presidential election cycle seems to be loose, naïve to various complications, dependent on a small sample years past, blind to current economic realities. However, calendar cadences are not entirely useless. Over the course of a year, there is always a rhythm of cash flow, tax payments, corporate messages about the year ahead, as well as habits and superstitions. Since 1928, of any day of the year, the three-month return was the best on October 25, according to Renaissance Macro. It was last Tuesday when the gang started looking past the abysmal results of Big Tech’s favorite platforms Meta Platforms and Microsoft to push higher. The odds may be even slimmer: October 28 to November 2 were the strongest five days, on average, at such a time of year – an anomaly first brought to my attention some many years by Larry McMillan of McMillan. Analysis, which trades this through S&P 500 options. He modified it to show that the signal is even more likely to work when there was at least a 3-4% pullback in October (it there were some this year). Friday’s 2.5% jump gives this system a pretty good chance of coming to fruition in 2022. More generally, going into September, it was hard to avoid being told this was the worst of all. months for stocks over decades. The temptation to blur such a well-publicized fact in the spirit of “what everyone knows isn’t worth knowing” would have hurt. Last September was a brutal one, with the S&P 500 down 9.3%, with a biased decline towards the second half of the month, just as the seasonal script had dictated. October, notorious for its volatility as well as its upside reversals, also conformed, rushing to a new bear market low on October 13 before climbing to a nearly 9% gain so far. Positive Midterm Election Pattern So we’re approaching Halloween, and the year-end trend of strength is amplified by the widespread repeat of the midterm election year twist. Since 1950, the S&P 500 has never declined from November to April in a mid-year. And the index’s 12-month return following such an election, since 1960, has exceeded 20%, according to Citi. This has been true regardless of the division of power between parties. Gains in the months following “every midterm election since 1950” appear to be a lock. But that still only represents 18 cases over that period, not exactly a large statistical sample. As recently as 2018, the fourth quarter of a mid-year was a terrible one for equities, redeemed only by a dovish shift by the Federal Reserve that contributed to a comeback in early 2019. In other respects, this year has not quite matched the historical pattern. Remember all the talk that stocks tended to rally until the first Fed rate hike? This market peaked two months before “take-off”. If a recession awaits in 2023, stocks will have peaked “too early” based on the average 6-9 month timeframe. And if we’re not yet in (or already out of) a recession, then the Oct. 13 low would have been “too early” to be the last, because stocks in the past have never reached a trough before the onset of a recession. In fact, the only such pattern still intact would be if there was no recession on the horizon and it was a nasty cyclical bear market with no recession, as we saw in 1962 with 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 general trends but not dictating how to dress for the elements at any given time. In terms of the ongoing rebound, the seasonal tilt probably helps, but so does the fact that investor sentiment and positioning at the start of October was deeply pessimistic and defensive. The fact that the market has been in tune with seasonal trends is at least the absence of a negative – markets that defy major trends (don’t rally when heavily oversold or fall on good economic news) reflect an underlying weakness and can be treacherous. The bullish case In fact, as October dawned, many bearish watchers were opposed to the idea that stocks would soon be relieved due to washed out technical conditions and seasonal relief passing around the S chart. &P 500 from 2008. At this point, the 2022 path matches up reasonably well. Of course, the market crashed again in October 2008 on the way to a heartbreaking low in November (before the ultimate low in March 2009). With the current 12% two-week ramp, the index has now deviated sharply from the trajectory of 2008. Beyond the potential seasonal benefits now, the bull case may hang on still defensive sentiment and under -investor exposure to equities, as well as the band’s refusal to gain downward momentum well below June lows and the ability to rally on bad news (hot CPI report Oct 13, massive deficits tech earnings and stock declines last week). This is happening, above all, during a moment of relief from the upward spiral in bond yields, with a hint that the Fed may soon slow its pace of tightening, with an earnings season that is on the whole fairly normal and not alarming ( 70% of companies beating reduced forecasts), and that the economic data has not yet distorted in a way that indicates we are past the tipping point into an impending recession. We’ve seen similar actions before, as recently as the summer, keep in mind. A 17% S&P rally from June to August on hopes of a dovish Fed turn and firmer macro data. That rally took the index all the way to the 200-day moving average before turning around, with Fed officials then pushing markets back to tighten financial conditions. The current S&P 200-day average is up about 5% from Friday’s close. A cautionary tale, for sure. This time, at least, the Fed is much closer to its supposed destination, a little more valuation risk has escaped from the biggest index stocks and, understandably, this is the season when the market often catches – but not always – a tailwind.
The market is moving almost perfectly in line with seasonal trends – Is the post-midterm rally next?