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October 01, 2010 at 01:09 PM
Thousands of years ago, King Solomon stated: “Expectation postponed is making the heart sick.”
Over the past few months, the stock market’s performance has been making investors sick as expectations from both bulls and bears go unfulfilled. The S&P 500 (SPY) has been stuck within the 1,040 to 1,130 trading range.
On the upside, the S&P has failed twice to stay above the 200-day moving average. On the downside, except for the July 1 low of 1,011, the S&P has found support around 1,040 on six separate occasions. The same general pattern has also emerged with the Dow Industrials and the Nasdaq Composite.
Let’s evaluate the evidence for both the bullish and bearish cases.
The Bullish Case
Reason #1: Stocks will rally due to the election-year cycle.
It is generally believed that the government won’t allow the stock market to fall before the November 2010 elections to the U.S. Senate.
According to the Stock Trader’s Almanac, the sweet spot of the four-year presidential term begins in the fourth quarter of the mid-term year (2010), and carries into the second quarter of the pre-election year (2011), with an average gain of 15% since 1950.
Contrary to the above pattern, the months of October, November and December have seen some of the biggest declines in the past decade. The last serious mid-term election year declines were seen in 2002 (-16.8%), 1974 (-27.6%) and 1930 (-33.8%).
The 1930 decline deserves a second look for a number of reasons. Following the initial 1929 meltdown, the Dow rallied 50% into the highs of April 16, 1930. Following a period of range-bound trading, stocks sold off sharply after September 10, 1930.
The rally into the April highs turned out to be the biggest sucker rally in history. Range-bound trading over the next few months gave investors a few more chances to cut their losses before the hammer dropped.
As a point of reference, stocks topped an April 26, 2010. Following the initial decline, stocks have remained range bound until the present.
Reason # 2: Sentiment is too bearish.
After the worst August since 2001, sentiment was indeed bearish, and investors expected the worst for September as headlines read, “A Cruel Month for Stocks.”
Investors were expecting a cruel September, but as usual, the market did the unexpected.
Nevertheless, the supposed bearishness of investors has created the train of thought highlighted in more recent headlines, like: “For Bad-News Bulls, Adversity is Opportunity.”
The common reasoning that prices will rise because sentiment is bad certainly seems more bearish than bullish.
Another side point, Triple witching occurred on September 19, 2008. Stocks held up from September 19 to November 21, after which the S&P lost 36%.
