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Since we are within a few weeks of the potential beginning of the market’s historically favorable season, it’s time to again bring up the subject of the market’s seasonality.

The volatility has made it an interesting year to say the least. The market topped out in late April, as called for by seasonality (Sell in May and Go Away). It then declined 17% to a low in late June, rallied back some in July, then experienced its worst August in nine years. But it has now rallied off that low for four straight weeks, in the process producing the best September in years. As a result, the S&P 500 is now only 6.2% below its April top.

Will seasonality work out this year? That would require the market to remain below its April top until seasonality’s re-entry signal, and preferably be considerably lower.

Seasonality doesn’t work out every year. But it works out so consistently that over the long-term it outperforms the market to a significant degree, while also avoiding large losses (since they most often occur in the unfavorable seasons), and while taking only 50% of market risk (since one is in the market roughly only six months out of every twelve).

There’s plenty of time for the market to go either way, to a level higher than at the exit in the spring, or to a significantly lower level.

Based on the decades-old ‘Sell in May and Go Away’ strategy, the time to re-enter is November 1. My own seasonal strategy, STS, which as the Stock Trader’s Almanac says, “almost triple’s the performance” of the basic Sell in May strategy, uses a momentum reversal indicator to better pinpoint the entries and exits. Its entry signal can come as early as October 16, or as late as early December.

So again, plenty of time for the market to go either way.

If the month to month reversals continue - the market down in May and June, up in July, down in August, up in September - October would be a down month.

October also has quite a history of being a mean month for the market. Both of the market’s historical crashes, in 1929 and 1987, took place in October, as did the mini-crashes of 1989 and 1997. The worst week in market history was the second week of October in 2008, in which the Dow plunged 18.2%.

There are other reasons to expect seasonality will work out to produce a lower market rather than higher by the time seasonal re-entry signals are triggered. One of the more interesting is investor sentiment, which has been made very bullish and complacent by the September rally.

For instance, the poll of its members by the American Association of Individual Investors reached a level of 50.9% bullish a couple of weeks ago, a level that is usually a warning sign. It has dropped back since, but that doesn’t change the warning. The poll usually only reaches a warning level for a week or two before beginning to reverse. It reached a level of 48.5% bullish for just one reading, on April 15, two weeks prior to the market top on April 26.

We are also entering the third quarter earnings reporting period, with a potential dark cloud overhead regarding it. More than twice as many S&P 500 companies have warned their earnings will not meet Wall Street’s estimates than pre-warned prior to the second quarter earnings reporting period.

Then there is the continuing predominance of negative economic reports, indicating the market probably got ahead of itself with its September rally, in anticipating that all is well with the economy again.

So, in my opinion anyway, we enter October with the odds still high that seasonality will prevail, that the unfavorable season is probably not over until the seasonality rules say it’s over.


Disclosure: No positions

Source: October Blues? Seasonality Revisited