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Don’t Be “Spooked” by October Volatility

Historical Trends Suggest “Sweet Spot” on the Horizon Following Mid-Terms



Over the last few months there have been numerous articles highlighting the poor historical performance of financial markets during the month of September in a mid-term election year. However, as of September 27th, the S&P 500 is actually higher for the month. According to Oppenheimer’s technical analyst, Ari Wald(1), a higher September in mid-term election years for the S&P 500 has historically confirmed an uptrend in the market. While we believe a stronger September for the S&P 500 index is a positive historical signal regarding market trends over the next 6 to 9 months, we believe the potential for increased volatility during the month of October is also a potential outcome.

Entering the “Sweet Spot” for Historical Investor Returns

According to data from Oppenheimer(2), the fourth quarter and first two quarters of the following year following mid-term elections are the best performing quarters during a four-year Presidential cycle. Since 1926, the fourth quarter and first quarter of the next fiscal year, have generated roughly ~6% average returns per quarter following the mid-term election. Supporting Oppenheimer’s historical data, UBS(1) suggests that, on average, the S&P 500 has rallied ~14.5% from the end of August through the end of March following mid-term elections. UBS also noted that the rate of increase in financial markets often accelerates following the beginning of the next calendar year.

September Volatility May be Pushed into October

Given positive S&P 500 momentum during the month of September, which contradicts historical trends, we believe market volatility typically seen during the month of September may be pushed into October during this year’s mid-term election cycle. With many headwinds such as global trade, the stronger dollar, emerging markets, increasing interest rates, and ongoing political issues facing the market, we believe a pause or downturn is likely during the month of October. If October were to mimic historical September trends during mid-term election years, we would expect the first few weeks to trend lower with markets beginning to move higher towards the end of the month and ahead of November mid-term elections.


Cyclicals, Defensive, and High Yield Best Performers Following Mid-Terms

According to data from FactSet, the three best performing sectors historically following mid-term elections have been cyclical and defensive companies’ shares along with high yield debt. On average, cyclical stocks have seen gains of ~15% following the six months after a mid-term election. We are unsure if FactSet is including dividends in their average return calculation, but many leading cyclical companies are offering attractive yields, as well as, the potential for future share price appreciation. To a lesser extent, FactSet’s historical data also suggests that investors should look to diversify into global companies. The S&P 500 has underperformed the MSCI All World Index by ~2-3% in the six months following mid-term elections. We are unsure how high yield debt may perform during this mid-term election cycle given the recent interest rate increase by the Federal Reserve, with expectations for further increases over the coming quarters, coupled with mounting investor concerns regarding rising debt levels on corporate balance sheets.

Stay the Course, The Trend is Your Friend

Given our expectations for historical returns to remain intact following the mid-term elections, albeit potentially pushed-out by a month or so, investors should utilize any October volatility as a mechanism to increase overall allocation to equities. If investors lack exposure to historically favorable sectors following mid-term elections, such as cyclicals or defensive-based names, we believe October volatility could provide an opportunity to diversify away from higher priced sectors such as technology. With the downturn in emerging markets over the last few months, investors may also want to diversify their geographic exposure to more non-U.S. based companies. As we near the potential “sweet spot” for investors over a four-year Presidential cycle based on historical data, we don’t believe near-term volatility will derail the continued uptrend for financial markets over the next two to three quarters.



Sources:

(1) – Victor Reklaitis, Forget the September Stock Slump and Brace for the Market’s ‘Best 9-month Stretch’. 2018. https://www.marketwatch.com/story/forget-the-september-stock-slump-and-brace-for-the-markets-best-9-month-stretch-2018-09-04

(2) – Tory Newmyer, The Finance 202: Saddle Up for the MidTerm Stock Market Slump. It Begins Now. 2018. https://www.washingtonpost.com/news/powerpost/paloma/the-finance-202/2018/04/03/the-finance-202-saddle-up-for-the-midterm-stock-market-slump-it-begins-now/5ac2a83d30fb042a378a303d/?noredirect=on&utm_term=.65e4f9ea1603

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