Broker Check

Gearing Up for the Fourth Quarter

| October 05, 2020

We’re now in the fourth quarter of a wild year. And considering some recent events, it’s more important than ever to rely on data, not the television pundits

Last week marked the end of a dismal market month, the traditionally weak month of September. But it also marked the beginning of the fourth quarter, which is historically powerful.

As in many sports, you can ignore the first three quarters because the fourth quarter is what, historically, really matters. The table below shows average returns for the Dow Jones Industrial Average over the last 20 years. It’s gained 4.5 percent in the fourth quarter versus 1.14 percent in the previous three quarters combined. Notice the typical third quarter dip, which we’ve discussed before.

Going back to 1950, the S&P 500 averaged 4.53 percent for the first nine months of the year. For the final three months, it averaged 4.05 percent, or almost as much as the first three quarters combined.

There are some technical explanations for this historical anomaly. In our opinion, the most important one is fourth quarter earnings announcements include not only the previous quarter’s performance, but also guidance for the upcoming year. This allows for more certainty, which markets like.

The historical case is clear. But many of our clients rightly ask if this year will be similar.

Well, some firms have already released forward-looking guidance (even reversing course after saying there would be no such announcements). We think that trend, along with direction on future capital expenditures and actual earnings performance, will drive growth momentum in the fourth quarter as expectations keep growing for a continued 2021 economy economic recovery.

We’ve also been asked if a controversial election throws a wrench in historical data. Remember, the market cares about facts, not emotions or political wishes. Also remember, in the last 20 years we’ve had controversial elections.

In 2000 it was “hanging chads” in Bush v. Gore. In 2008, the Obama/McCain election took place during a financial crisis. The contentious 2016 election is still fresh in everyone’s minds. And none of those even take into account the included the 24-percent market drop in the fourth quarter of 2018, but is included in the 4th quarter averages.

In other words, the average returns over time include a lot of controversy and volatility, regardless of whether an election is taking place or not.

During the chaotic elections of 2000, 2008, and 2016, there wasn’t an incumbent. This time around there is, and each time there’s been an incumbent running for reelection since 1950, we saw full market gains. Plus, all but 2012 delivered a positive fourth quarter:

Keep in mind, those fourth quarter returns aren’t much different than the aforementioned average fourth quarter return of 4.05 percent that dates back to 1950. Election year returns are a bit less on average, but within the ballpark for sure.

With all that being said about history, let’s turn to current data – specifically tracking institutional “big money” through Map Signals’ Big Money Index (BMI).

We don’t think there will be a complete smoothing out of volatility, especially in October. But as mentioned last week, once election results are final, big money tends to re-enter the market quickly as more certainty arises.

Some of our industry discussions are presenting a consensus that the market hit its bottom about 10 days ago. However, the BMI data indicate there hasn’t been a complete flush-out of the selling yet.

Even during the late-week market increase on September 24 and 25, the BMI was still showing selling pressure. We prefer when markets reverse trend toward the upside. We like buy signals.

But last week, we saw the opposite. The weekly totals were 437 big money sells and only 53 buys.

We also like sector leadership from the market bottom. But there’s been no clear leader yet. Notice how all the yellow indicators in the last column below are for sells:

Digging a bit deeper, we’ve analyzed trade volumes. As the following table shows, there has been significantly more trading on down days:

So, overall history says the fourth quarter will be strong, while current data suggest more selling could occur, possibly due to some extra political uncertainty. But even knowing that, the market pullback has provided a good entry point. Thus, we’re in the process of picking our spots to allocate the rest of the cash we have on the sidelines.

Grow, Plateau, Awaken the Coasts for More

Over the past week we’ve had further positive U.S. economic news.

For instance, existing home sales rose 2.4 percent in July, which is 10.5 percent higher than a year ago. At the current annual sales pace, the inventory of existing homes for sale is down 18.6 percent in the past year, leaving only a three-month supply.

Also, new homes sales rose 4.8 percent in August, to an annual pace of 1.011 million. Amazingly, these sales are up 43 percent compared to last year. Even more amazing is how 2020 new home sales through August dwarf new home sales for all of 2019.

The current inventory sits at only 282,000, which is 3.3 months of supply at the current annual sales pace. As a result, we expect this new housing boom to continue going forward.

On the jobs front, the good news is continuing unemployment claims declined by 167,000 to 12.58 million in the latest week’s data. Job losses are still a problem, but the situation is getting better.

Lastly, the Commerce Department reported durable goods orders were up 0.4 percent in August. It is the fourth straight monthly gain, which is encouraging. Also, shipments rose 1.5 percent.

As these data troves come out, they reaffirm the Federal Reserve Bank of Atlanta’s gross domestic product projection of 32 percent annualized growth in the third quarter.

That is a welcome revelation, though we’re also seeing a flattening of growth. However, it doesn’t seem to be due to a lack of household income. The Commerce Department’s measure of personal income is still 4.9 percent higher than it was in February 2020. Rather, it could be due to restrictive conditions.

So, to sustain accelerated growth rates, we’ll need a full economic reopening to reawaken American spending power. New York and California are critical here because they have 18 percent of the total population but claim 32 percent of all unemployment benefits (due to economic activity restrictions).

Simply put, we’re in a plateau. But we can arise from it, especially with the help of the coasts.

Securities sold through CoreCap Investments, LLC.  Advisory services offered by CoreCap Advisors, LLC. Cornerstone Financial Services, CoreCap Investments, and CoreCap Advisors are separate and unaf´Čüliated entities.