DON’T LOSE SIGHT OF WHERE WE ARE IN THE CURRENT MARKET CYCLE
Now that fear, myopia, nausea, depression, tears and vomit have quickly resurfaced as we experience the first real correction of the Q4 rally, it is a good time to put aside emotions and focus on hard facts.
I present these facts to you as an active market participant who believes the October lows will be retested, as discussed last weekend. However, it will not occur until the psychology of the market falls in line. In order for that to happen, it takes time and it takes momentum.
Given the amount of persistent bearishness, there remains little possibility that the first multi-phase correction of this bull run will break the back of the market and make it humble. It will take more time and it will take more upside momentum to cause the psychological shift necessary to see the markets fall.
Now that everyone has lost sight of the fact that this is a seasonally favorable time of year, it is a good time to give a refresher course as to where we are seasonally:
- S&P 500 during the 4th quarter has averaged a 2.4% gain since 1928. The past 20 years the gain has
been 4.6%. The gains during the 4th quarter are twice as strong as the next closest quarter.
- When the market has fallen by more than 10% during the 3rd quarter, a rally in the 4th quarter has not
failed since 1957. The last seven instances were:
1974 Q3 -26.12% Q4 +7.9%
1975 Q3 -12.21% Q4 +7.54%
1981 Q3 -11.45% Q4 +5.74%
1990 Q3 – 14.52% Q4 +7.83%
1998 Q3 – 10.32% Q4 +20.85%
2001 Q3 – 15.03% Q4 +10.38%
2002 Q3 – 17.68% Q4 +7.98%
2011 Q3 – 14.38% Q4 +7.43% to date
- The 4th quarter following a double digit percentage decline during the 3rd quarter averaged a gain of 9.7% since
1974 and 5.5% since 1928.
The sentiment picture coming out of the abyss in early October was the most dismal of any period over the past twenty years. That kind of psychological backdrop creates time for the bulls. That's a very important point to remember. By "time" I mean that the market requires a window, often measured in months, to reconfigure the psychology to the point where it allows the market to resume its downtrend, as most expect.
As of now, we remain in that window of time where the psychological backdrop and seasonal backdrop continue to favor the bulls. Furthermore, we have now pulled back to the bottom of a month long range on the S&P 500.
We are positive by 7.43% thus far in Q4. By looking at the data above, you can see that 7.43% is at the bottom of the expected range given the past incidences where Q3 experienced a double digit percentage decline. Given the persistent negative psychological backdrop and the improvement in the overall fundamental picture, I would expect that, at a minimum, we finish Q4 in line with the average gain of 9.7%. With the high likelihood that we in fact exceed that number.
With 28 trading days remaining in 2011, we now have a very defined picture of what to expect for the remainder of the year. The risk versus reward has become defined to a point where putting cash back to work in the market will be the most profitable course of action.
