Don’t fear Octoberphobia

Last week we called an audible on the blog and suggested buying into any market weakness during the Rosh Hashanah holiday instead of the usual trade of selling ahead of the holiday and buying on or before Yom Kippur. Over the years we have observed market weakness during this brief period. But this year we felt that with the market selling off as it often does in the week after Q3 triple witching (last week), Rosh Hashanah would be a better entry point than exit.

So far the close last Thursday on the first day of Rosh Hashanah was the low of this minor end-of-September correction. Yom Kippur may prove to be just as fine an entry point as the stock market appears to be consolidating here over the past few days. Despite some rather tense situations overseas, broad commodity weakness and a strong dollar, the U.S stock market has been rather resilient.

The small-cap Russell 2000 index is down about 6.5%. It has broken through monthly support and is testing the August lows. The next support level is around 1080 near the February and May lows. Russell 2000 has also been inflicted by the infamous “death cross” where its 50-day moving average fell below its 200-day last week. Small caps have been leading the market higher and lower this year, so this needs to be watched. But for now the major large cap indices (DJIA, S&P & NASDAQ) are only off 2.5%-3.0% since the high early this month.

This is a puny pullback in the face of pro-democracy protestors taking it to the streets of Hong Kong, continued cold war style maneuvering with Russia, near-regular war with the Islamic State and the midterm elections on the horizon – not to mention the end of quantitative easing. In the our “Market at a Glance” and the “Pulse of the Market” we note the improved sentiment picture, where excessive bullish has eased, technical and internals are getting oversold and the sweet spot of the year and 4-year cycle are upon us. 

October’s first trading day not so bullish

According to the Stock Trader’s Almanac 2014 (page 84), the first trading day of each month combined produce nearly double the gains of all other days. However, based upon DJIA, October’s first trading day is rather meager as the seventh best performing first trading day of all twelve months with DJIA gaining a cumulative 339.01 points since 1997. Over the past 21 years, DJIA’s first trading day of October has produced gains just 57.1% of the time with an average gain of 0.19%. S&P 500 has advanced 52.4% of the time. NASDAQ has been notably weaker at just 42.9% with an average loss of 0.39%.

Crude’s seasonal slump expected to resume

A little more than two weeks ago we alerted our newsletter subscribers to crude oil’s seasonal to decline from mid-September through mid-December. This year crude has been in decline since reaching a peak in June. Crude’s strength until then was primarily due to typical seasonal demand from the summertime driving season supported by rising geopolitical tensions. Both factors have faded and our best buy idea was to establish a long position in ProShares UltraShort Bloomberg Crude Oil (SCO).

This trade looked especially timely as we noted strong U.S. crude oil production growth that is forecast to push domestic oil production to its highest level in decades. Furthermore, a strengthening U.S. dollar is also putting pressure on crude oil’s price. Weakening demand and firm supply growth is usually a good recipe for lower prices.

SCO has not yet been added to the Almanac Investor ETF Portfolio because it has failed to trade at or below its suggested buy limit as crude oil has modestly firmed over the past week. Once the third quarter comes to an end, we anticipate crude’s decline to resume, especially if geopolitical concerns remain mild. SCO around $29 would still be an attractive entry point for this trade.

October is best performing month of midterm year

October often evokes fear on Wall Street as memories are stirred of crashes in 1929, 1987, the 554-point drop on October 27, 1997, back-to-back massacres in 1978 and 1979, Friday the 13th in 1989 and the 733-point drop on October 15, 2008. During the week ending October 10, 2008, Dow lost 1,874.19 points (18.2%), the worst weekly decline in our database going back to 1901, in point and percentage terms. The term “Octoberphobia” has been used to describe the phenomenon of major market drops occurring during the month. Market calamities can become a self-fulfilling prophecy, so stay on the lookout and don’t get whipsawed if it happens.

But October has become a turnaround month—a “bear killer” if you will. Eleven post-WWII bear markets have ended in October: 1946, 1957, 1960, 1962, 1966, 1974, 1987, 1990, 1998, 2001 and 2002. Eight were midterm bottoms. Current market weakness could be setting up October 2014 to be another “turn-around” year. 

Midterm election year Octobers are downright stellar thanks to the major turnarounds mentioned above; ranking number one on the Dow, S&P 500, NASDAQ and Russell 1000 and second for Russell 2000. This is also the beginning of the sweet spot of the four-year-presidential-election-cycle. The fourth quarter of the midterm years combines with the first quarter of the pre-election year (2015) for the best one-two quarter punch for the stock market, averaging 15.3% for the Dow and 16.0% for the S&P 500 (since 1949), and an amazing 23.3% for NASDAQ (since 1971).

British Pound rallies on seasonal cue and Scottish “no” vote

Two weeks ago we caught a falling knife. As the British Pound was in virtual freefall, down about 6.5% since mid-July in a near panic selloff over fears that Scotland might split from the United Kingdom; we issued a buy idea on CurrencyShares British Pound (FXB) to our newsletter subscribers.

We felt the Scottish independence vote would be “No” as did the London bookies and the overdone selloff was setting up nicely with one of our top long Pound trades that runs from mid-September to early November. In addition, recent Bank of England Governor Mark Carney comments suggests interest rates are likely to increase in the UK early next year, which is bullish for the Pound.

We added FXB to the Almanac Investor ETF Portfolio on September 9 at 158.53. FXB traded above 161 over the past few days and closed today at 160.64, off 55 cents. A further pullback below 160 would still be an attractive entry point for this trade. 

September’s revenge, support levels eyed

After breaking out to new highs last week, DJIA, S&P 500 and NASDAQ looked well-positioned to keep the streak of recent September gains intact and overcome the month’s tendency for declines since 1950. What a difference two trading days can make, especially during the frequently treacherous week after September options expiration. DJIA, S&P 500 and NASDAQ are all in the red know for September.

In the charts above, recent market weakness has turned stochastic, relative strength and MACD indicators negative across the board. These indicators have yet to reach oversold levels suggesting there is still room for further modest declines. However, this pullback is likely to be short-lived and just another excellent opportunity to enter or add to new or existing long positions ahead of the best two-quarters of the four-year cycle. Key support levels (green dashed lines) are currently around DJIA 16570, S&P 500 1937 and NASDAQ 4408.

Buying instead of selling Rosh Hashanah

As detailed in the Little Book of Stock Market Cycles, during the High Holidays many Jewish colleagues take off to observe the Jewish New Year and Day of Atonement and many schools in the New York area and elsewhere close sometime during the holidays. With many traders and investors busy with religious observance and family, positions are closed out and volume fades creating a buying vacuum.

It’s no coincidence that Rosh Hashanah and Yom Kippur fall in September or October, two dangerous and opportune months. Passover conveniently occurs in March or April, right near the end of our Best Six Months Switching Strategy. Perhaps it’s Talmudic wisdom but selling stocks before the eight-day span of the High Holidays has avoided many declines, especially during uncertain times like 2008. Being long Yom Kippur to Passover has produced more than twice as many advances, averaging DJIA gains of 7.0%. This trade has worked for five years straight and particularly well in 2009, 2010 and 2011.

This year Rosh Hashanah begins at sunset on Wednesday, September 24. This also happens to fall in the middle of one of the worst weeks of the year, the week after September options expiration. However, instead of selling ahead of the holiday, we would be looking to buy any market dips this time around. The economy is on reasonably firm ground with growth and employment in positive trends and the Fed is still rather accommodative.

Week after September options expiration, one of the worst weeks

Although DJIA and S&P 500 managed to close at new all-time highs this week, celebrations could be short-lived as fund managers tend to clean house as the end of the third quarter approaches. In the table below, it is clear that next week, the week after September options expiration, has consistently been one of the worst of the year. Since 1988, weekly declines average from –0.88% for NASDAQ to –1.43% for Russell 2000. S&P 500 has only posted full-week gains five times in the last 26 years.

The Best is Yet to Come

According to the soon to be released Stock Trader’s Almanac 2015, the Worst Six Months, May through October have only averaged a 0.3% DJIA gain since 1950 versus a 7.6% average gain during the “Best Six Months”, November to April. For S&P 500 the gain is slightly better at 1.3% during the “Worst” and 7.1% in the “Best” over the same time period. As of the close yesterday, DJIA was up 3.5% and S&P 500 6.2% since the last trading day in April.

Better than historical averages indeed, but still short of what the “Best Months” have historically generated. The market’s resilience in the face of mounting geopolitical concerns throughout the “Worst Months” this year is impressive and suggests that the upcoming “Best Months” could also be above average. But, before the Best Months begin the market still has to navigate weak end-of-Q3 seasonal factors and the frequently troublesome month of October. With solid fundamental data and an accommodative Fed at its back, any market dips between now and the end of October are likely to be a great entry point for the next “Best Six Months” cycle.

Bulls win battle between donkeys and elephants

It’s amazing how little press and media attention the midterm elections have garnered this year until just recently. With the control of congress hanging in the balance we were expecting more hype from party central, but it has been rather subdued this time around. It’s not as if Obama is the most popular president, au contraire, and everything is hunky dory here in the States and around the world.

Midterm elections are usually quieter with lower voter turnout than the presidential election – but not this quiet. In fact, it is this low turnout out that usually fuels the inherent House seat loss by the president’s party. The fervor that brought the sitting president in has cooled and the opposition is usually more zealous on the local level, generating congressional gains. But this year there are several hot button issues in play right now and perhaps that is dragging attention away from the midterms.

ISSUE #1: Geopolitics. Eastern Europe and the Middle East are the hotspots of the day – activity on the other volatile geopolitical fronts from Asia to Africa have been on the back burner recently. Even the situation in the Israel/Gaza theater has subsided somewhat. It’s pretty much all ISIS (Islamic State in Iraq & Syria or ISIL or just IS) all the time these days.

Granted the Islamic State is a nasty bunch of violent extremists and arguably the most formidable terrorist group at present, but we are not convinced the IS threat is so great. If it were, the US military would not be tiptoeing around with airstrikes and a long haul plan. If IS was such a clear and present danger, we would not be keeping US ground troops off the table – that is infantry and marine divisions not combat advisers.

While IS has quickly swept through the Levant and is controlling some prime oil real estate, they have no air force (and killed anyone who could maintain and operate the air materiel they captured) and no navy and somewhere where between 20,000 and 31,500 fighters of dubious capabilities. Most findings indicate that they have little heavy armor and firepower and instead sweep in like a Viking raid in the Dark Ages to pillage and plunder and have little capacity to hold territory.

Yes, they have been cruel and lethal and successful until now. But it seems over the top to commit so much attention to such a small rag tag force, just because they may strike the West. Perhaps this is the Obama administration’s military distraction. Or perhaps it’s pride messing with us because this is happening in the bed we made in Iraq.

The more pressing geopolitical issue would seem to be what Putin is trying to do in Ukraine and Eastern Europe and potentially on all his borders. Left unchecked Putin will run roughshod over his neighbors and international diplomacy. But if more containment and sanctions are levied on Russia and begin to squeeze the economy it may be able to change the high regard in which the Russian people hold Putin so that he will change course or be removed.

ISSUE #2: Immigration. Nobody wants to touch this right now with a ten foot pole, not to mention an opinion poll and it is not likely to be addressed until 2015 and its doubtful anything will get through unless the Republicans take control of the Senate. Then we may actually have the potential for reconciliation between the House and Senate on this and some old-fashioned compromise between a Republican Congress and Democratic White House. But we are not sure we’d take that action.

ISSUE #3: Obamacare. Well, after a lot of skepticism and wrangling (including from us internally), the Affordable Care has not hurt people as much as its fiercest opponents intimated and it does not seem to igniting any fire in the midterm campaigning. Sure the usual suspects continue to mention it, but it does not seem to be resonating widely.

ISSUE #4: It’s the Economy Stupid. The stock market says it all. As the mother of all economic indicators, the stock market is voting thumbs up on the economy. Sure there are weak spots – nothing’s perfect – but economic conditions are clearly positive and improving and a great deal better than they were 5-6 years ago. Whether Obama had anything to do with it or not, it reflects positively on his administration and the Democratic Party. With the market virtually yawning at these four issues and pushing higher through it all, the likely impact on the midterm election will be favorable and boost the market in the near term and over the next several months.