The stock market has shown weakness in September, but will this weakness continue into October before the seasonally strong period begins?
Historical data has shown that the last two weeks of September and the first two weeks of October tend to be weak for the market.
However, it’s important to note that the major market crashes, such as the “Financial Crisis” in 2008, have contributed to the significant down moves during this period. Excluding those crashes, the market still tends to be weak but more flat.
It’s worth noting that historically, the summer months tend to be the weakest for the market. On average, $10,000 invested in the market from November to April has performed much better than the same amount invested from May through October.
Interestingly, the market has seen significantly larger drawdowns during the “Sell In May” periods. Some important market declines, such as those in October 1929, 1987, and 2008, have occurred during this time.
So far this year, the May through October period has been average, with a return of 6.74%. Even if there is some additional weakness, overall it should still be a positive period for investors.
However, it’s worth mentioning that this year’s weakness came a bit late, with a 5% correction starting in August.
It’s important to understand that the overall market performance has been heavily influenced by a few big stocks with large market capitalization. The performance of the broader market, excluding these stocks, has been significantly different.
An equal-weighted index, which gives equal importance to all stocks, shows a clearer picture of the market’s weakness from May to the present, with a return about 200 basis points weaker than the market-cap weighted index.
As we approach the end of the seasonally weak period for stocks, let’s consider the potential market drivers into year-end as the seasonally strong period begins.
Driving Ms. Daisy
Three primary drivers are likely to influence the market from the middle of October through year-end.
The first is earnings season, which starts in two weeks. As is common, analysts have significantly lowered their earnings expectations heading into the reporting season. It’s worth noting that analysts are often wrong in their estimates.
“This is why we call it ‘Millennial Earnings Season.’ Wall Street continuously lowers estimates as the reporting period approaches so ‘everyone gets a trophy.’”
The chart below shows the changes in Q3 earnings estimates from February 2022, when analysts provided their first estimates.
With lowered expectations, companies are more likely to beat earnings estimates, which could fuel stock prices in the short term.
Additionally, professional managers have reduced their equity allocations during the summer months, creating negative short-term sentiment. As stocks start to move higher, these managers will begin to chase performance, further pushing prices higher.
Due to the divergence between the market and the equal-weighted indexes this year, there is additional pressure on managers to catch up with performance by the end of the year.
This pressure, combined with the fear of significant underperformance and the reopening of corporate share buyback windows in November and December, could lead to additional buying pressure in the market.
According to Goldman Sachs, corporations could buy $5 billion worth of equities daily during this period.
Don’t Forget About The Risks
The overall market backdrop supports a rally into year-end, with portfolio managers buying stocks for reporting purposes and historical data showing stronger fourth quarter returns in years with stronger first three quarters.
However, it’s important not to dismiss the potential risks, such as elevated interest rates, slowing economic data, and tighter financial conditions.
Low levels of market volatility also raise a warning sign, as previous periods of low volatility have eventually led to higher volatility.
While low volatility can last longer than expected, a reversal is inevitable. The timing and cause of such a reversal, however, are unknown.
For now, the market continues to show a bullish bias, but it’s important to closely monitor the risks. If the warning signs prove incorrect, adjusting the portfolio to take on more equity risk is simple. However, if the warning signs materialize, a more conservative stance will protect capital in the short term.
By reducing volatility, investors can make logical adjustments as the correction becomes more apparent, avoiding panic selling. Remember the “Golden Investment Rule”: “Buy low and sell high.”
