Equity Markets to Track Higher in September Before Election Correction

By Jeff Saut  AUG 27, 2012 10:15 AM

The stock market continues to track the typical election year chart pattern.


Peter Drucker was a writer, consultant, and teacher who was deemed the father of modern management theory. His groundbreaking work turned management theory into a serious discipline, and he influenced or created nearly every facet of its application. He coined such terms as the “knowledge worker,” which plays to the intangible capital theme often discussed in these missives.  One bòn mót he once related was:

The most enduring lesson I’ve ever learned came from an old janitor at New York University, which had completed a new magnificent graduate-school building that had no windows on the first nine stories.  We moved in; and, you know there’s always a short, brutal heat wave in New York at the end of April.  The temperature went from 80 to 90 to 100; and everybody, the women included, stripped down to the barest essentials.  It continued to get hotter and my patience wore out!  I went down to hunt-up the janitor and scream at him.  Way down in the third basement I found an old toothless man and yelled at him, "Can’t you read a thermometer?" He looked back at me and said, "Mister, if I could read a thermometer what would I be doing as a janitor?!"

Indeed, the janitor’s job was to watch the calendar because in New York you heated the building until May 15 and then you turned on the air conditioner.  The janitor merely followed the orders he had been given – no questions asked!

In the stock market, many mavens also follow the calendar ... you simply play the summer rally long; then around Labor Day, you sell because of the “look out for October” history-haunts. They read the calendar, not the temperature, of the markets. 

Unfortunately, many investors failed to participate in this summer’s rally, conditioned by the shared experience of the past two summers.  Indeed, for the last two years, the S&P 500 (SPX) has topped out in the spring and then slid into the summer doldrums. Accordingly, many professional investors were too timid to believe the June 4 low was the daily, and intermediate, term cycle-low, which launched this year’s summer rally. Now they are faced with performance anxiety as the end of the third quarter looms. Yet investors are still skeptical, voicing concerns about Euroquake, a slowing China, our dysfunctional government, the fiscal cliff, etc.  I have addressed most of these concerns in prior missives.

Nevertheless, the single most reoccurring “knock” I have heard since the bull market began in March 2009 is that the volume has been extremely low by historical standards.  In theory, that “knock” makes sense, but followers of said theory have missed out on the ninth strongest Bull Run in the history of the S&P 500.

To this “low volume” point, the eagle-eyed folks at the Bespoke organization had this to say:

In order to illustrate the fallacy of this argument, the chart below shows the performance of the S&P 500 since the bull market began on March 9, 2009 along with its performance if we took out all days where volume (as measured in SPY) was below the 50-day moving average.  So far this bull market [has left] the S&P 500 up 108.5% (blue line).  If you back out all days (up and down) over the same period where volume was below average, you come out with a decline of 30.1%.  Bears can argue whatever they want, but if you followed the low volume argument, you would be down 30.1% instead of up 108.5%!

This week, however, volume will not be the question du jour as participants put on “rabbit ears” for what is said at the Jackson Hole meeting.  Indeed, the Kansas City Federal Reserve will again host the annual Federal Reserve meeting near Yellowstone National Park with the highlight being Ben Bernanke’s Friday morning speech where Wall Street will be looking for hints of future policy moves. 

If you will recall, I was wrong-footed at the last Fed meeting in thinking that there would be a change in Mr. Bernanke’s policy statement.  My reasoning was that the Fed would change its policy statement on fears it would be viewed as too political by changing its policy statement at the September meeting, which is so close to the presidential election.  Accordingly, this week’s Jackson Hole’s affair may be the last chance for the Fed to act. 

That said, while the economic figures have strengthened over the past few weeks, this pattern did not hold last week. Whether that will cause Ben Bernanke to lean toward another quantitative easing should be the focus of the week.  If QE3 is the “call,” the SPX should vault above the previous reaction highs of 1420 – 1422 with price objectives of 1477 and then 1509.  If not, it likely implies the indices will have to spend more time digesting the ~12% rally from the June 4 low. 

Whatever the outcome, I think any correction will be shallow with the path of least resistance remaining to the upside with the “carrot in front of the horse” being the under-performance by the pros staring at the end of the quarter performance derby. Manifestly, most investors I know are dramatically underperforming the major indices.

Last week, however, the under-invested crowd got a break as the SPX snapped its six-week winning streak. This should have come as no surprise after the SPX’s first attempt to travel above its April highs failed.  As stated, it usually takes two, or even three, attempts before a successful upside breakout occurs. 

Also, as anticipated, the pullback was shallow, indicating the bulls are still in control; and while the momentum has been lethargic, there are no clear-cut bearish divergences that typically occur at topping formations.  Indeed, at a “big top” the Relative Strength Index (RSI) will diverge and fail to confirm new reaction highs in the broad averages.

Furthermore, the leading stocks continue to lead.  Typically, if a top is forming, the leaders lag and the laggards lead and that is just not happening.  All said, the picture looks pretty good with the stock market’s daily internal energy level back to a full change.  That puts the SPX in great position to vault above the 1420 – 1422 level and keep pushing higher.

As for my comments on gold last week, gold looks to have broken out to the upside, and in the process has traveled above its 200-day moving average.  To me, this looks like the start of a move higher and not the end of a move.  Coincident with gold’s upside breakout, Credit Suisse penned a report on Freeport-McMoRan Copper & Gold (FCX) with a favorable rating. The report’s byline reads, “The cheapest growth stock in our universe.”

The call for this week: Hurricane Isaac blew into the Gulf, but is having little effect here in Tampa. Still, like a snow day up north, the schools are closed and the Republican National Convention is taking the day off.  The stock market, however, is not as it continues to track the typical election year chart pattern, as can be seen in the chart below from the good folks at Bespoke. If the correlation continues to hold, the equity markets should track higher into the beginning of September before giving us a more substantial pre-election correction.

No positions in stocks mentioned.

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