Trader Savvy Newsletter


July 26, 2006

Sponsored by:
Free Offer from XpressTrade

COMPLIMENTARY Daily Futures Trading Strategies
Click Here Now!


Will History Repeat a Bearish Fall for Stock Indexes?

Name: Matt Krupski

Company: Lind-Waldock

Learn More About Today's Author
Years Trading : 7

Favorite Movie : Caddyshack

Will History Repeat a Bearish Fall for Stock Indexes?

Historical returns in no way guarantee future performance in any market. However, looking back on past seasonal market trends is a worthwhile exercise for investors, because often, patterns tend to repeat themselves. Over the past 12 years, from the late 1990s into the early 2000s, there have been some extremely volatile periods in the stock market during the third quarter and early into the fourth quarter. Historically, the period from August – October has been the worst for stock market performance. There’s even an old market proverb to describe this strong seasonal tendency of third-quarter declines and year-end recoveries: “sell in May and go away, buy in October and get yourself sober.”

Interestingly, harvesting made August the best month for the stock market from 1901 – 1951, according to the Stock Trader’s Almanac. Now that agriculture no longer dominates our economy, it has become the worst month for the S&P 500, the second-worst for the Dow Jones Industrial Average and third-worst for the Nasdaq. And, it’s been a month of some high-profile meltdowns. Turmoil in Russia brought a record drop of 1344.22 points in the Dow in August 1998, and in August of 1990, actions related to Saddam Hussein in Iraq inspired a 10 percent decline. September likewise is ranked at the top of the worst-performing months for the major market averages. October has also seen some high-profile market crashes, but also marks the end to many seasonal bearish trends with some equally impressive recoveries as the year-end approaches.

In recent years, stock market action has been more subdued than the stomach-churning conditions from the 1990s and into the early 2000s. This situation is reflected in the CBOE Volatility Index, or VIX, amid historically low options prices. However, I think this year volatility may heat up. Global tensions are high, energy prices are hovering at sky-high levels, and we have a possibility of both inflation and a slowing U.S. economy—what economists call stagflation.

A Look at the Data

Let’s look at the data. I’ve created a table of the monthly opening prices of S&P 500 futures from January 1994 through the present, and calculated the monthly percentage change of the S&P based on the opening price for that month. So we are looking at a month-to-month percentage change basis, with green boxes representing the highest positive change on the year, and the red boxes the largest negative change on the year. We have one high and one low each year, or 24 moves, reflected in this table. What’s interesting to note is that from 1994 to 2004, only six of the largest moves happened before June. Historically, the largest moves both up and down over the past 12 years have come in July or later. If these patterns do replay themselves, we should have some decent moves coming between now and the end of the year. The period from July – November tends to get some big swings.

 

I’ve also drawn up a table of the total up and down moves by month over a 12-year period. In August, the average percentage change over the past 12 years has been -1.6 percent. While it doesn’t sound stunning, if you look at the numbers on the chart, that’s a pretty large average move down compared with other months. While there have an equal number of up and down moves in August, the down moves have been much greater, and August performance has been the worst month by far for the year during this timeframe. Once the end of the year approaches, the market starts turning positive more so than not. As a result of this analysis, I would conclude the third quarter of the year tends to be rocky, and is something we need to be cognizant of as traders. Toward the end of the year, perhaps we’ll get a bounce back up, and I’ll be watching for signs of that as well.

Market Fundamentals

Now that we’ve taken a look back, let’s take a look at the current fundamental environment for the market.

Energy prices and tension in the Middle East dominate headlines, and have been influencing the market. We also have global hot spots like North Korea in the fray. In my opinion, the economy can’t withstand this situation for an indefinite time period. Some analysts see $100 per barrel crude oil soon on the horizon, and the extent to which rising energy prices will cool the economy remains to be seen. There’s a time lag from when rising energy impact various areas of the economy, from manufacturing on down the line to the consumer. 

Then there’s inflation overall. Is it under control? Is the Federal Reserve done tightening after its series of 17 increases in the short-term lending rate since June 2004? That’s the buzz in the markets, and is going to be a major factor playing out in the economy in the third quarter. If we start to see inflation in conjunction with a slowing economy, that’s not going to be reflected well in the performance of the S&P 500. Under these conditions, the market would likely sell off.

How will the recent increases in interest rates affect the consumer on a large scale? During the low-interest rate era that inspired a housing boom earlier this decade, many consumers took out adjustable-rate mortgages. We are starting to enter a period when those ARMs are coming due. If many current home owners are overleveraged, and their mortgages are going to adjust to the higher market rate we are in now, is that going to lead to foreclosures? How overleveraged did the consumer get? And will that contribute to the slowdown in housing? These are all questions to ponder, and factors that are likely to impact the economy and market.

A housing slowdown has already been seen in recent data. If it slows further, like energy prices, we’ll likely have a trickle-down affect impacting not only mortgage brokers and real estate agents, but construction and manufacturing.

With all these uncertainties on the table, I am preparing for a bearish and more volatile period ahead. Volatility creates a lot of opportunities for both day traders and swing traders; you can catch a big move and ride out a trend. But you also need to be careful, we can see big up move as well as downs moves that can really shake out traders who aren’t prepared. Use good money management techniques, and work with a professional if you need help determining a viable strategy for your particular situation.

Short-Term Technicals for S&P Futures

As far as my short-term view for the September S&P 500 futures contract, after breaking through the 50-day moving average and resistance near 1269 this week, the market is making a run at a resistance area around 1282. This area was previous resistance in early July and late May, and a trend line from the May highs comes down in this area. While we could continue this week's uptrend, I wouldn't be too bullish as August approaches. On top of the factors I mentioned earlier, we have a Federal Reserve policy meeting coming up on August 8, and that could be the catalyst to turn things lower.

Please feel free to call me at 877-847-3034 or contact me via email at mkrupski@lind-waldock.com if you have questions on this topic or to discuss specific trading strategies for your unique situation in this or other markets.

You can hear market commentary from Lind-Waldock market strategists through our weekly Lind Plus Markets on the Move webinars, as well as webinars on other topics of interest to traders. These live, interactive webinars are free to attend. Go to www.lind-waldock.com/events to sign up.

Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.

Futures trading involves substantial risk of loss and may not be suitable for all investors. © 2006 Lind-Waldock® a division of Man Financial Inc All Rights Reserved. Futures Brokers, Commodity Brokers and Online Futures Trading. 141 West Jackson Boulevard, Suite 1400-A, Chicago, IL 60604.

About Today's Author