October - Where Bear Markets Die
Many investors associate October with down market expectations, mainly because of Black Thursday in 1929 and Black Monday in 1987. October is the opposite in midterm election years as it represents the best-performing month for the Dow and S&P and the second-best-performing month for the Nasdaq and Russell 2000. The month also means the beginning of the ‘Best Six Months’ for the market historically.
One major characteristic of the October market, which is very timely, is that the month is known as the “Bear Killer.” Of the 13 bear markets in the S&P since WWII, October has marked the end for 11 of them. And of those 13 bear markets, seven were during Midterm Election Years. The chart below shows the 11 bear markets that ended in October. This data shows where the market opened each year on January 1 and where it ultimately bottomed. It also includes the S&P 500 percentage loss from the start of the year and the forward return of the S&P one year from the bear market low.
For 2022, the US stock market losses are comparable with the historical loss average of previous bear markets. We want to deliver the message that, as painful as this year is, "we have been here before." And investors eventually made back all of the losses in due time. If 11 of those previous 13 bear markets bottomed in the month of October, then we feel that there is above average probability that we could finally bottom as well. Of course, no one can know for sure, but if the past does repeat itself, we could experience some powerful gains over the next year if history stays on our side.
As we have been sharing with our clients all year, the average S&P 500 return from the Midterm market low to the high of the following year since 1930 has been roughly 47%, for the Nasdaq this return since 1974 has been 70%. While the market is not out of the woods, we believe we are much closer to finding that ultimate bottom to trade out of as we start to move into the pre-election year. Remember that bottoms are made when it appears that there is very little hope going forward. Indeed, that is what the consensus feeling is today.
Powerful Inflation Influencers
“This year has been among the worst, if not the worst, in several generations for diversified investors. The last month only served to make things worse”
- SentimenTrader - October 5, 2022
2022 has been the worst year for a traditional 60/40 stocks to bonds allocation since 1937. No conventional asset allocation would have been able to find shelter in the first three quarters of 2022.
Most of the blame for the current market conditions can be directed toward the Federal Reserve and our policy makers. The Fed has raised rates faster in 2022 than any other time in history, and they are also running off their balance sheet at the highest level than we have seen in the past. The Fed is using the only two tools in its toolbox to tame inflation but are not receiving any help from government policymakers who continue to print money and drive up our national debt. Even after the $1.9 Trillion American Rescue Plan Act the government continues to print more money at an alarming rate. What is most interesting is that the increase in monthly inflation saw its most significant increase in decades between March 2021 and April 2021 after the Act had millions of Americans given thousands of dollars at their disposal. Even now, California is actually handing out more money to its residents to the tune of $9.5 billion. Perhaps our government officials should take a mandatory economics class to learn what causes inflation: When demand for goods and services exceeds an economy's ability to produce them. More "free cash" drives demand for goods and services while our country is still dealing with supply chain issues. Yet no one seems to be working diligently on the supply chain issues. Instead, they are working on killing demand and the jobs that pay for these goods and services. Perhaps they will finally realize this at the next Fed meeting in November.
As we have been saying for a few months now, much of our daily technical data has a more bullish tilt to it than one would expect based on the market’s price action so far this year. Today we will look at a few indicators that we have not touched on before:
50- & 200-Day Moving Averages
At the end of September, 11% of the S&P 500 constituents were trading above their 50 day moving averages. This represents one of the lowest readings we have seen over the last 20 years and is entering a period where we saw significant reversals in the past.
Also, at the end of September, 17% of the S&P 500 constituents were trading above their 200 day moving averages. This was the lowest reading since Covid and is inline with the significant lows we saw in 2011, 2016, and 2018.
Three critical features of these readings:
The move we have seen over the last two months, where the number of stocks above their 50-day moving averages dropping from +80% to below +20%, is rather extreme. Over the last 20 years, we have seen a move from an overbought reading to an oversold reading in such a short time. Drastic moves like this usually are climactic washout events that quickly reverse themselves moving forward.
Looking at several S&P stocks above their 200-day moving averages, we are what has been at extremely oversold levels in the past. Specifically, the move lower in 2011 is very similar to what we are seeing today, this indicator bottomed out at 9% at that time, so we might look for one more thrust lower in this indicator before it reverses higher.
While they still may chop around for some time, both readings are in oversold areas that have historically produced significant bottoms in the market.
Commitment of Trader’s (COT) Data: S&P Futures
To better understand where commercial traders and speculators expect future moves to occur, we will examine the Commitment of Trader’s data from the Chicago Board of Exchange. Below is the most important in our data set, as it shows where these traders are positioning their S&P 500 futures. Commercial Traders (red line) are out to their most prominent net long position on S&P futures since late 2011, as they anticipate the market moving higher over the coming months. On the other hand, the Non-Reportables or Speculators are at one of the largest net short positions they have been in since the same period in late 2011.
While it may take some time, history shows that the big money Commercial Traders almost always end up being right with their future bets.At the same time, the speculators or non-reportables almost always end up being wrong with their bets, providing an excellent contrarian indicator.The chart below from Bloomberg shows the periods in the past where the speculations have been this short on their S&P 500 futures, and each marked a significant bottom in the overall market.
October Market Expectations
September lived up to its renowned status of it traditionally being the weakest month of the year. The Fed actions have made the market extremely illiquid, maybe the most illiquid market we have ever seen in quite some time. Because of this, any piece of positive or negative news will cause exaggerated reactions within the market, like what we saw last month.
Below is a comparison chart like the one we sent out last month; this one is from Ned Davis and the 2022 Cycle Composite dating back to 1928. It includes the One-Year Seasonal Cycle, the Midterm year of the Presidential Cycle, and the 10-year Decennial Cycle. The blue line represents the averages of these moves since 1928, while the yellow line represents the S&P 500 index for 2022. We are again at a historical point on the calendar where a trend change has traditionally happened. Is this pattern going to matter? Will the market right itself during the month?
We have one primary data point for the month: the September CPI data release, which will occur premarket on Thursday, October 13th. The market and all the algorithms that run it have become hyper-focused on CPI data, so we expect any print with the slightest hint of lower inflation to be extremely market positive. At the same time, for any print that shows the anticipated strengthening of inflation, as happened in September, we would expect the stock market to continue its path of weakness. We continue to see several month-over-month changes that would lead us to speculate that inflation will begin to fall in a meaningful way.
While we are hopeful that all of our bullish data points and historical patterns will finally lead the market in the right direction, we understand that volatility will remain extremely high and any outcome is possible. October is the best month on the calendar in midterm years, but it will be challenging to get stocks moving higher until the Fed pivots in some capacity. Frankly, after the weakness seen in late August and all of September, even a flat October with improving inflation data would be welcomed. The next Fed meeting is on November 3rd, and this may be a more appropriate time for the Fed to offer some form of positive relief and power stock prices higher into year-end. However, the market is always sniffing out the next move, and stocks could very well begin to advance ahead of the Fed meeting. Stay tuned and stay invested.