Current Letter To Clients {Part II}

Market Seasonality: There are seasonal patterns to markets that exert themselves throughout the year. We discussed this back in a post on March 23rd at our blog Solas! If you are reading this online you can follow this link here to that post: Solas!: Where We May Be Going or readers of the printed version can type in this blog address: http://lumencapital.blogspot.com It will take you to the main page and you can access the archives if you want to review what we said back then. One of the prime points back then was this. “While market declines can come at any time, statistically stocks are most prone to major sell offs in between the months of March and October…..of course there is also no law that says this has to occur. However we have to add this factor into the equation given the fact these seasonal patterns exist and given where we are in the calendar."

One of the reasons I think this pattern works is the philosophy behind how most of what we refer to as institutional money is invested. Institutional money is a generic term for large institutions such as pension plans and large asset managers such as mutual funds. It is managed on a relative basis usually tied to a specific benchmark and is also managed so as to not give up the assets. By relative basis I mean as an example in a market that loses ten percent, institutional accounts that go down only 8% are said to have outperformed their peer group. That influences how their portfolios are set up. Institutions generally start a year with similar economic and valuation expectations for stocks.

Institutions have a very strong incentive to be heavily invested in the early months of a new year. They are afraid to fall too far behind their benchmarks. Their thinking is similar to that of a baseball manager at the beginning of a long season. The manager knows you don't win a pennant in April but you can lose one. As the year progresses and in particular if stocks have advanced in the first few months, equities begin to look less attractive on year end expectations. Stocks will either need unexpected positive news {better than expected earnings news or higher economic forecasts for example} or prices will begin to stall out.

Stocks will fall of their own weight unless there are marginal new bidders for their shares. Summer is typically a down period for Wall Street as the news flow often dries up {unless it’s bad news. It is amazing how many international crises begin in the late spring/summer period. Both World Wars, the Korean War, 9/11, the First Gulf War and the 2008 banking crisis are examples of this.}

Summer is also when analysts begin to fine tune their expectations for stock prices as clarity begins to enter the picture about year-end economic activity. Stocks will also begin to discount any lower revisions or negative economic news during this period of seasonal weakness. Once this discounting process is completed stocks will usually then begin to rally sometime in autumn. The cynical amongst us also know that the only print that matters for most money managers is the one shown when the market closes on December 31st. To put it simply Wall Street wants to get paid. So there is a strong incentive to boost share prices during the 4th quarter of the year.

2011 so far is a good example of this process {though of course we don’t know how this year will end}. We discussed in December our expectations that stocks as represented by the S&P 500 had the potential to trade between 1,350 and 1,400 by year-end 2011. On May 2nd the S&P 500 printed a close of 1,361.22. By early May we had already reached the lower end of my price targets. Since the estimates I use are available to nearly everybody then it is likely that consensus expectations for most analysts were somewhere near my own levels. Stocks at this point, in order to rise, needed that extra push in the form of better economic news. That has been decidedly lacking these past few months. So share prices have stalled leading to the current listless random action.

*Long ETFs related to the S&P 500 in client and personal accounts.