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Will the Fed Spoil the Stock Market's Best Six Months?

October 20, 2015
Fall and the Fed

It’s that time of year—the stock market’s typical best six months. It’s the start of a well-chronicled seasonal and historical market tendency for U.S. stocks to outperform from November through April compared to May through October. So what’s different this year? Uncertainty around the timing of the first Federal Reserve interest rate hike since 2006. It looms over stock investors like a black storm cloud that just won't burst or blow on by.

"It's a potentially different six months than normal because there is an over 50% probability [based on Fed funds futures market pricing] that the Fed could raise rates at the tail end of it," says JJ Kinahan, chief market strategist at TD Ameritrade. Fed funds futures contracts currently project a 54% chance the Fed will raise rates at its March meeting, with paper-thin chances for a rate hike priced in for the October and December meetings.

Numbers Story

Since World War II, the S&P 500 (SPX) has gained an average 6.7% from November through April compared with a 1.1% gain from May through October, says Sam Stovall, managing director at S&P Capital IQ.

Chalk it up to some pre-holiday cheer perhaps, but Q4 numbers have tended to be solid. Since 1990, the SPX gained an average of 4.9% in Q4 and price for the period rose 80% of the time, according to Stovall. History shows the advance is broad-based during this time. All 10 SPX sectors advanced in price, including average gains of more than 6% for consumer discretionary, consumer staples, and technology, and just shy of 4.5% average gains for energy, financials, and utilities.

Seasonal factors that inject capital into the equity space are among the influences, says Stovall. Those include: year-end and early-year additions to pension fund holdings; 401(k) and individual retirement account (IRA) max-out contributions; and year-end bonuses or tax refunds that get funneled into the stock market.

Prep for the Weather

Markets could be more skittish than usual, Kinahan says. “While investors gear up for the stock market's traditional ‘best six months,’ there may be a little less commitment; investors may take profits more quickly and change their positions," he says.

Kinahan notes four market approaches that could help investors prep for whatever the Fed delivers.

  1. Be nimble; conditions can change quickly.
  2. Monitor the CBOE Volatility Index (VIX) futures—all months, not just the nearby. Look out in time to see what the market is expecting ahead. For instance, November monthly VIX futures stand at 17.37 versus a higher 19.30 for March futures, reflecting expectations of increased volatility ahead.
  3. Long-term investors might think of partial moves as opposed to going all in at the start of the historically strongest six-month stretch. In other words, consider keeping some powder dry.
  4. As the VIX goes up, there’s typically a higher probability the S&P 500 will go lower (figure 1). Long-term investors may get an opportunity to buy at lower levels if volatility goes higher.
Volatility overlay with SPX and VIX

FIGURE 1: TRACK VOLATILITY. This one-year view charts the S&P 500 (SPX) with an overlay of CBOE Volatility Index (VIX) futures. Create this chart by first opening the Charts tab on the thinkorswim® platform. Enter SPX in the symbol box in the top left corner, then go to the Studies drop-down in the top right corner. Select Quick Study > Compare With > Custom Symbol. Type in symbol /VX. Source: Standard & Poor’s, CBOE. For illustrative purposes only. Past performance does not guarantee future results.

S&P Capital IQ’s Stovall downplays the potential roadblock from the Fed during the upcoming “bullish” seasonal period. While conceding that "history is a great guide, but never gospel," Stovall points to an investing population that shouldn’t be surprised by a Fed rate hike given so much chatter around Fed meetings. “Much of that action has already been priced in” to the stock market, he says.

In fact, as the market approaches the start of this bullish seasonal time period, the SPX is rebounding after a 12% correction from the July high to the late-August low. Traders who monitor so-called technical chart patterns for potential clues to future price activity have highlighted a bullish double bottom pattern on the daily S&P 500 chart, seen off the late August and late September lows.

Could the stock market rally strongly out of this base into year-end? Only new history will tell.

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The information presented is for informational and educational purposes only. Content presented is not an investment recommendation or advice and should not be relied upon in making the decision to buy or sell a security or pursue a particular investment strategy.

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