The recent market decline has many people wondering if this is the start of a bigger correction, or just a shakeout before a fourth quarter rally. I’m leaning towards the latter for the following reasons: seasonality, the Fed, technicals, and sentiment.
Seasonality is a short-term negative, but a positive into year-end. From approximately mid-September until mid-October, factors such as index rebalancing and end-of-the-quarter portfolio adjustments can lead to seasonal weakness. These factors, along with debt ceiling concerns, are currently contributing to the volatility in the market.
When we come out of this, we will begin one of the strongest seasonal periods of the year. According to the Stock Trader’s Almanac, October is traditionally strong, but after volatility and weakness in the early part of the month. Following that, November and December are two of the three strongest months of the year (according to data since 1980). Market participants just need to be patient as we get through some near-term seasonal weakness.
The Federal Reserve meets every six weeks to discuss monetary policy. In their upcoming November meeting, they are expected to announce their “tapering” schedule. This is their plan to reduce the $120 billion in monthly bond purchases that began in the spring of 2020 as the coronavirus pandemic was taking hold.
My feeling is they won’t begin tapering until early 2022, and even if they start earlier, their reduced buying will still be providing a substantial amount of liquidity into the markets. In addition, their near-zero interest rate policy will likely remain until 2023. Bottom line, the Fed will still be providing the backdrop for an equity friendly environment.
For the most part, the S&P 500 has held its 10-week moving average since the middle of 2020. This technical average is important because it’s an area of institutional support. The index has closed slightly below it recently, but I fully expect it to regain that level after we get through this seasonally weak period. In addition, the Nasdaq Composite continues to hold a key area around 14170-14180. As seen in the chart below, I view this recent pullback as a retest of the prior February and April highs.
There are also many sectors that continue to act well. Financials and Energy are close to 52-week highs, and growth sectors such as Semiconductors, Medical Products, Retail, and Software are building technical bases. Many stocks in these groups have seen recent bullish option activity, showing that big institutions are speculating on higher prices into year-end.
There’s an old saying that the market tends to fool the majority. Right now, many market participants have one foot out the door. Several sentiment surveys continue to show that investors are holding high levels of cash and are consistently buying puts on every drop. From a contrarian point of view, this consistent fear keeps the market from seeing aggressive follow through selling.
Over the near-term, the biggest requirement is patience as the market still needs to get through this seasonally weak period. Coming out of that, we will be heading into a traditionally strong time to be in the market. The equity friendly backdrop provided by the Fed should help propel the market into new highs by year-end. If you trade individual equities, stay focused on the stocks showing the strongest technicals and fundamentals, and always manage risk if any position turns against you. Good luck!
