Selloff Coming In October, But Be Ready To Buy When It Does

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Includes: SPY, VXX
by: Mark Diestler

Summary

Election year with congress controlled by one party.

Very Low Volatility.

Octobers in Years Ending in '7' have been rough.

Investment Thesis

Even though the market is currently at all-time highs, there is an apparent pull back right around the corner. Analyzing recent charts with similar characteristics matched with 'October-phobia' and this market is ripe for a pullback (albeit unlikely a deep pullback). But be ready to buy that dip as that same analysis demonstrates a rally into December and new all-time highs.

Since the election in November 2016 the market has been strong and has managed to fend off any big pullbacks. The market has demonstrated some clear attributes this year - politics and unprecedentedly low volatility certainly come to mind. I believe there are some previous examples we can look at to get a slight edge here.

Points to Consider

1. A single party is controlling all 3 branches of congress this year

I'm not going to get into politics per say, but I do like to track possible equity moves based on historical political control. The last time Republicans controlled congress in an election year was 2005 (not Presidential election year). Democrats controlled congress during the Obama administration in 2009 but the market was rebounding off the massive sell-off following the financial crisis - not in line with today's market, an aging bull. Therefore, let's look at the last time the Democrats controlled congress (prior to 2009) in an election year, which was 1993.

2. The market has demonstrated extremely low volatility this year

Cross checking this year's volatility (VIX) and daily moves of 1% or greater (another tool I use to track volatility) against historical data, it's clear that both 2005 and 1993 also demonstrated extremely low volatility. Extended low volatility in the past has demonstrated more gains to come. That doesn't mean the market will continuing only going up, there will be spouts of increased volatility and dips in prices along the way.

Let's take this one step further and look at charts from the Presidential election through the end of the year following the election for 1993, 2005, and 2017 (probably just a coincidence, but they are each 12 years apart and all demonstrate very similar characteristics) - the charts don't all have the exact same moves - but as Mark Twain once said, "History doesn't repeat itself but if often rhymes." I believe that is what we are seeing this year.

  • All 3 charts took off after election into year end.
  • Then new high in early March.
  • Weak into mid-April.
  • Rally into early/mid-June.
  • Weak into 4th of July.

Then the charts start differing a bit - possibly caused by how much congress was able to achieve and geo-political risks? Up to this point overall gains for 2017 are closer to 1993, but actual moves (short term tops and bottoms) are lining up very closely with 2005, when Republicans last controlled congress. You can see weakness in October 2005 in the chart below.

S&P 1993
S&P 2005

S&P 2017

3. 'October-phobia' has been rough in years ending in '7' - like this year

Looking at historical S&P index data starting with 1950, maximum drawdowns in October (daily low) for each year ending in '7' from the closing price on the last trading day in September are as follows:

  • 1957: 8.1%
  • 1967: 3.5%
  • 1977: 6.6%
  • 1987: 32.7%
  • 1997: 9.7%
  • 2007: 2.4%
  • 2017: ???

Summary

While the market looks very strong, I think you will have an opportunity to get in at a lower price in October. Valuations are high. Seasonality is weak. The Feds are unwinding massive debt. Volatility is extremely low. MACD (momentum) is about to cross negative.

That being said, I would be looking to buy right around the 200-day moving average, currently at 2385. That may seem like a big move to the downside in this market, but it's less than 5%, well within norms for the month of October, especially those ending in '7' and it's roughly the same move percentage wise as in October 2005. If we follow the 2005 chart as a 'guide' expect a short-term bottom in October and a strong rally into December. Using 1993 as a 'guide' and we may not get much of a pullback at all. Of course, depending on what happens in Washington, tax reform, North Korea, etc. always be on your toes.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.