As we enter the final trading month of the year we find the major US averages more or less break-even for the year, many money managers behind their benchmarks and hedge funds having their worst year since 2008. A lot of folks need the market up this month to save their performance years. Therefore probability suggests, given the seasonal patterns, that stocks have a stronger bias for positive performance this month than any other time perhaps this year. We've talked in the past on our theory of seasonality and the theory of how institutional money is invested, but I think it bears repeating today:
"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 during that time. 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 {i.e. better than expected earnings news or higher economic forecasts for example} or prices will begin to stall out. One of my concerns right now is that the markets have had such a strong move that much of the economic expectations are already priced into stocks. If companies don't excessively move the needle higher on earnings and sales going forward than investors, especially those with a shorter term horizon, may begin to lock in their profits.
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."
Think about it. If you're a money manager and you as well as other institutions can goose the major indices up 2-3% this month {while throwing in dividends of 1-2%} then your year looks a bit more reasonable. A 2-3% move in the S&P 500 from yesterday's close would put the index in a range of 2,120-2,145. A close on the high end of that range would give us nominal new highs but wouldn't be that much different than levels we saw back in the early summer. Of course there's no law that says this has to happen. For all we know this December will break a long standing seasonal pattern we've seen in almost every year I've been in this business. But I think there's a stronger probability that we see this occur and I wouldn't be surprised if we see that 1-2% move this month.
And for those of you that want to scream about excessive valuations, well we can have that argument another time. But even if you're right. Even if stocks are truly expensive and should trade down that 10-20% I hear folks like you throw out all the time then I'll tell you what the average portfolio manager is going to say, "I'll worry about that in 2016". For now it seems to me that the seasonal patterns may just be in our favor for the next month or so.
So now we must end with the usual caveats and cautions! If you're going to go long based on this thought process then I'll remind you of the following. What I've posted above is opinion. It may be educated opinion, but it is opinion non-the-less. It has a certain probability of being wrong and I will acknowledge that it has a higher probability of being wrong this month then perhaps in other years given the current state of the world. You should not act on anything you read here without discussing the above with your financial advisor or doing your own individual research or better yet, hire us. If you do act on your own after reading this consider yourself warned.
Having a busy week so I will post here next either Thursday or Friday.
*Long ETFs related to the S&P 500 in client and personal accounts although positions can change at any time.
