Be Ready For A Solid Fourth Quarter

by: Codespeed

During the past three years, the market has appreciated significantly during the November to April timeframe. Take a look at the performance of the S&P 500 Index SPDR (NYSEARCA:SPY) during these months.

  • 11/1/2009 - 4/30/2010: 13.89%
  • 11/1/2010 - 4/30/2011: 15.10%
  • 11/1/2011 - 4/30/2012: 14.65%

On the other hand, each year, the month of May has started a bearish trend in the entire market, causing the market to underperform during the remaining months until November.

In his book Riding The Bear (published many years ago), Sy Harding used the performance of the market indices in all the months of each of the previous 50 years to conclude that investing in the November-April timeframe produces overall better results than the remaining months. Of course, this strategy has not always worked, especially in bear markets. For example, the performance of the SPY in 2007 (-8.46%) and 2008 (-9.23%) in those months was pathetic. Nevertheless, if you backtest the overall market performance for the past five decades, there is some credence to this theory.

With or without considering this theory, I believe that at least for the fourth quarter of 2012, and especially before the Fiscal Cliff chatter accelerates in early 2013, we should see a mini bull rally -- mainly because the Fed has provided assurance of affirmative action whenever needed, and because the earnings estimates for the third quarter are too low, which could result in a number of positive earnings surprises. In early 2013, I expect increased uncertainty because of Fiscal Cliff discussions, and even market pullbacks, especially in sectors that have dependency on sequestration and budget cuts.

So if you agree with this justification, with the Q3 2012 earning season ahead of us, it is important to keep a stock list ready. Let us discuss some criteria that can help in creating your watchlist.

Tips On Picking Stocks

(1) Growth Strategy:

If you want to pick investments for your portfolio, pick companies that have reported a high growth rate in earnings as well as revenues, and have given a positive outlook for the coming quarters.

Look for actual EPS and sales trends in recent quarters, and then look for the EPS and revenue estimates in the next quarters. For retail investors, most brokerage accounts, as well as investment websites like SeekingAlpha and Yahoo/Google Finance, provide such details. For the company's investment outlook during earnings calls, it is very important to listen to the earnings calls or read their transcripts on SeekingAlpha.

For example, in July, we had used a combination of various EPS trends in this article, and recommended the following stocks:

Company Price at recommendation (07/17/2012) Current price (10/05/2012)

The Manitowoc Company Inc. (NYSE:MTW)

$10.88 $14.13

Textron Inc. (NYSE:TXT)

$22.97 $25.78

Apple Inc. (NASDAQ:AAPL)

$606.91 $652.59

Caterpillar Inc. (NYSE:CAT)

$81.15 $85.43

Chicago Bridge & Iron Co. NV (NYSE:CBI)

$37.12 $39.27

Now that these companies have appreciated well since we first reviewed them, take note of those companies that have announced any negativity recently. For example, Caterpillar's CEO had said the company was lowering outlook for 2015 because of a likely decline in mining spending. If you think this stock has become a risky long-term investment, take profits and move on (although personally, I still think that Caterpillar is a decent buy).

(2) Growth + Value Strategy:

There are other ways of picking stocks as well, like using valuation metrics such as Price/Sales or Price/Book ratios, but many times, relying only on these metrics is dangerous because such a strategy fails to detect value traps.

Instead, use a combination of these valuation ratios, along with earnings trends.

For example, in this July article, we used a combination EPS trends and valuation ratios (Price/Book and Price/Sales) to recommend the following stocks:

Company Price at recommendation (07/18/2012) Current Price (10/05/2012)
Ashland Inc (NYSE:ASH) $69.40 $73.00
Lithia Motors Inc. (NYSE:LAD) $24.92 $35.87
Johnson Controls Inc. (NYSE:JCI) $27.49 $27.85
Raymond James Financial Inc. (NYSE:RJF) $34.01 $37.50

Once again, it is important to use the earnings call transcripts on SeekingAlpha and understand what the company's management is saying about the outlook for the coming quarters.


In September 2012, the Fed promised to take required actions as and when needed (or what the Wall Street calls "QE-infinity"). My take on this is -- do not fight the Fed.

In spite of the diminishing returns of more quantitative easing, and all the debates about qualitative versus quantitative easing or Keynes versus Hayek economics, Wall Street is usually relieved and toggles to risk-on mode when the Fed steps in.

Obviously, investors must remember that there are no guarantees in investing, and should take into consideration risk factors associated with individual companies and sectors.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.