The Big Finish!

Our regular readers know that we are big proponents of the idea that the time of year can affect stock market returns. This is referred to as “seasonality.”

In financial theory, where we are on the calendar shouldn't matter. However, it does in the real world of trading.

There are many reasons why it has an impact.

Companies report financial results every three months or “quarter.” They are also measured on a calendar year basis, which means that their results and guidance can change throughout the year.

The 3^rd quarter is often volatile because companies no longer have enough of the year to compensate for disappointing results. These results are usually reported in October but previewed in September if there is a problem.

This is one reason why September has historically been a tough month for the market. Here is a table showing the average monthly returns for the S&P 500…

This year, September went against this trend, and the S&P 500 was +2.1% for the month.

The seasonality trends are about probability, not certainty. This year, we saw some volatility to start the month, but there were not many negative pre-announcements or bad economic news.

This now sets us up for the end of the year, and seasonality has been strongest here by far.

Here are a couple of tables from one of our favorite research shops – Bespoke Investment Group – that show the average return and how often the stock market is up in the fourth quarter…

You can see that since World War II, the S&P 500 has been up almost double the average for all quarters and positive almost 80% of the time.

Those are both solid returns and a high probability of a positive outcome.

We discussed how the earnings reporting season can drive weakness in September and October. Why does the year-end lead to market strength?

It is for similar reasons having to do with the calendar.

Most professional money managers are compensated on a calendar year basis. At the end of the year, they are highly motivated to see the market rise.

They know they will get paid based on their performance as of December 31, so they will do everything they can to raise the market.

Also, if the stock market is strong going into Q4, then managers have a "cushion" with which to support it.

If a manager is flat or down going into Q4, then they are not likely to be aggressive and buy stocks when they are down.

However, if that manager is up solid double digits, then they are likely to buy every dip.

The stock market in 2024 is up historically. It is quite rare for it to hit a new all-time closing high on the last day of Q3, but it did so this year.

Here is another great chart from Bespoke showing when this has happened in the past and what happens in both October and Q4…

This is rare, having only happened four times since 1945. All four times, the stock market was higher in both October and the fourth quarter. The Q4 returns have also been solid.

We think we are likely to see a similar outcome in 2024, but we also think it makes sense to be cautious in the very near term.

Here is a chart from Ryan Detrick of Carson Investment Research showing what happened in October when the stock market was up more than 20% going into Q4…

The S&P 500 has been down most of the time, although there was only one bad month in 1987.

The strength of the stock market and economic data has pushed sentiment towards the high end of the spectrum.

Too many people on one side of the boat leave it vulnerable to volatility if it hits even a small stone in the river. That is where we think we are right now and would remain nimble in our trading allocations. Take profits when you have them.

We are cautious in the near term (weeks) and BULLISH on the stock market in the intermediate term (Q4).

Over the next year?

One last great table from Bespoke shows the BULL market's duration and magnitude since World War II…

The average duration has been over 1000 days, and the S&P 500 has more than doubled. We are about two-thirds of the way there on both measures.

We think this BULL has legs and will continue to run into 2025. Stick with it for the ride!