Seasonal Strategies

Market Outlook October 2018: Midterm October Launching Pad

Historically, the “Worst Six Months” (WSM) of the midterm year has been weaker than WSM in all other years of the 4-Year Presidential Election Cycle, with Q2-Q3 of the midterm year being the weakest consecutive two-quarter combo of the cycle. August and September have historically been the worst two months of the year, though they rank higher in midterm years, but have still posted average losses in midterm years since 1950.

This has not been the case this year. Despite a fast and furious, albeit not terribly deep, correction in the first quarter of 2018, ranging from 9.7% on the NASDAQ to
11.6% on the DJIA, the U.S. stock markets have performed quite well this year. Fed Chairman Powell may have put it best yesterday in his news conference following the FOMC’s decision to raise the Fed Funds Target Rate a quarter of a point.

In his official statement Chairman Powell stated that, “Both household spending and business investment are expanding briskly, and the overall growth outlook remains favorable. Several factors support this assessment: Fiscal policy is boosting the economy, ongoing job gains are raising incomes and confidence, and overall financial conditions remain accommodative.”

With all these gains so far in 2018, there has been much talk on The Street that it will steal from the Q4 rally and the “Sweet Spot” of the 4-Year Cycle from Q4 in the midterm year through Q2 of the pre-election year. While gains have been slightly lower during the Sweet Spot after YTD gains as of midterm September, they are still rather robust.

Following YTD-September gains in the midterm year this three-quarter Sweet Spot has produced average gains of 16.8% for the S&P 500 vs. 21.1% in all midterm year Sweet Spot rallies since 1950. And most importantly, fundamental and technical readings are supportive of further gains.

The Fed is forecasting a solid 3.1% GDP growth rate for this year and 2.5% for next year. Growth forecast don’t really begin to slow down until 2020 (2.0%), 2021 and beyond, with its long-run forecast at 1.8%. According to FactSet, “the earnings growth rate for the S&P 500 for the second quarter has improved to 24.6% today from 20.0% on June 30.”

As Chairman Powell stated above, job growth remains strong. This is keeping the Unemployment Rate historically low at 3.9% as reported by the U.S. Bureau of Labor Statistics. Weekly Initial Jobless Claims, according to the U.S. Employment and Training Administration also remain in a continuing downtrend since March 2009, currently just above historic lows at 214,000 last week.

Technically speaking, market internals are constructive with room for improvement. The Advance-Decline line is in an uptrend this year, though mixed as of late. New Highs and New Lows continue to battle it out as the market leaders are in rotation. The 50-day moving averages of the major averages remain in clear uptrends, which is supportive.

Market sentiment readings are high, but not at extremely exuberant levels that accompany market tops. Bullish advisors in the Investor’s Intelligence Advisors Sentiment survey are at 60.6%, which is high, but well below the 66.7% level we were at last January just before the correction. And with bearish advisors at 18.3% the bull-bear spread is at 42.3%, well below January’s high reading of 54.0%. Moreover, this survey began to hit these levels last October and ran for four months before the market began to correct in late January.

Furthermore, the recent new all-time high on the Dow helps to confirm the market’s uptrend and the Dow Transports also reaching new highs gives us a little Dow Theory confirmation. Yes, the market still has work to do, and we have Octoberphobia to contend with yet. So be patient and watchful, but get ready for the Sweet Spot rally.