Dow Jones Industrial Average and S&P 500: History Suggests Stocks Are Headed Lower

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September 12, 2013 1:10pm NYSE:DIA NYSE:SPY

bearbull21Mike Burnick: Stocks ended the holiday-shortened 4th of July week with a bang, which carried over to this week. But the real fireworks are still to come as investors digest second-quarter sales and profit reports in the weeks ahead. 

Equity markets have been granted a reprieve since the Labor Day holiday as the threat of a military conflict in Syria eases and economic reports suggest countries from the U.S. to the U.K. to China are improving.

Still, stocks are heading into what’s been historically a weak time of year. And 2013 may be no different in that regard, except it might be a lot worse.

Stocks tend to swoon in September and continue to decline in October, as seen in the chart below.

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Based on historical market data that stretch to 1928, the benchmark S&P 500 Index declines in September 60 percent of the time, posting an average loss of 1.1 percent. But that’s only the beginning.

Stock markets and the economy also tend to track a four-year presidential cycle. This is the first year of the cycle, and September begins the weakest period of this four-year pattern. Equities tend to perform even worse from September through year-end than is usual in an average year, and there’s more bad news.

Even though stocks have risen this month, a correction started in August, with the S&P 500 falling more than 3 percent last month. Historically, when August is down in the first year of this cycle, September is down even more often — 64 percent of the time, with a decline averaging 2.6 percent. Worse, stocks continue to fall in October, dropping another 1.3 percent on average.

Of course, as the standard disclaimer language reads: Past performance is not necessarily indicative of future results. The seasonal patterns don’t always play out, but since it’s based on more than eighty years of history, it’s worth paying attention to. Still, markets don’t move up or down in a straight line, and since the S&P 500 fell a bit too much recently, stocks may continue to rebound in the weeks ahead.

Looking at industries within the S&P 500, an interesting rotation is under way. Over the past 30 days while the stock market has been in correction mode, technology has been the best-performing sector, up 1.8 percent compared with a 0.5 percent decline for the S&P 500.

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Other economically sensitive sectors leading the way include: Materials, industrials and energy. Those represent cyclical sectors of the U.S. economy, and for them to be ahead of the pack during a correction phase tells me investors are convinced the U.S. economy is getting better.

If that’s the case, stocks could post gains again after this temporary correction runs its course.

At the opposite end of the spectrum, financial stocks have declined far more than the S&P 500 Index since the correction started in August. That’s a red flag, since banks and insurers were top performers for most of the year. Rising interest rates stopped that uptrend dead in its tracks.

Something else to keep an eye on in the weeks ahead is the health of credit markets. The sharp rise in U.S. interest rates, with the 10-year Treasury’s yield up more than 100 basis points (or 1 percentage point) since May has triggered bouts of instability in global markets, especially in emerging markets.

Emerging-market currencies, bonds and stocks, particularly in Asia, have been hard hit as a result of rising rates and fears that the era of easy-money is over. So far, the damage has largely been confined, and there hasn’t been much spillover of risk to the U.S. and Europe.

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As you can see in the chart above, credit markets have tightened dramatically in Asia (bottom panel), with currencies plunging and interest rates rising. So far there have been no ill effects on financial conditions in the U.S. (top), despite the sharp jump in yields and higher mortgage rates.

Closely watch that indicator because there’s a high correlation between tightening credit conditions and falling stock prices. Should Asia’s credit crunch persist and financial conditions deteriorate in the U.S., a steeper stock-market correction could occur.

Bottom line: Historical patterns suggest stocks may be susceptible to a deeper correction in September and perhaps into October, but if emerging markets can stabilize and financial markets avoid another global credit crunch, there should be good buying opportunities ahead, especially in economically sensitive sectors and stocks including technology, energy and materials.

Mike BurnickWritten By Mike Burnick From Money And Markets

Money and Markets is a free daily investment newsletter published by Weiss Research, Inc. This publication does not provide individual, customizedinvestment or trading advice. All information is based upon data whose accuracy is deemed reliable, but not guaranteed. Performance returns cited are derived from our best estimates, but hypothetical as we do not track actual prices of customer purchases and sales. We cannot guarantee the accuracy of third party advertisements or sponsors, and these ads do not necessarily express the viewpoints of Money and Markets or its editors.

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