Market Seasonality And The Fed Are A Powerful Combination

The market makes most of its gains each year in its favorable season of approximately October to May. A separate positive influence is the Federal Reserve when it’s providing easy money and low interest rates in an effort to revive a flagging economy.

Those individual influences are so consistent they’ve been memorialized in long time market maxims ‘Sell in May and Go Away’ (to come back November 1), and ‘Don’t Fight the Fed’.

Even in the unusual four straight years of unprecedented Fed QE stimulus, and record low interest rates, the seasonal factor did not go away (although it has been less pronounced). The market was at its strongest when the two influences were combined.

In the last four favorable winter seasons beginning November 1, 2009 through May 1, 2013, the S&P 500 gains averaged 12.8%.

In the last four unfavorable summer seasons to November 1, 2013, the gains averaged only 3.1%.

And even though, thanks to the increasing Fed QE stimulus each year, the market did not have serious corrections in its unfavorable seasons, the S&P 500 was down 0.1% for the unfavorable season in 2010, and experienced a 16% plunge within the unfavorable season before recovering. And it lost 7.7% for the unfavorable season in 2011, and experienced a 20% plunge within the unfavorable season before recovering.

Meanwhile, its gains in two of the last four unfavorable seasons, were an unusual gain of 9.3% in the unfavorable season last year, and 10.9% in the unfavorable season this year, as QE reached $85 billion a month.

We should enjoy the combination of those two positive influences while they last, but be prepared for what happens next, since it looks like for the first time in four years both will become negative at about the same time in the spring.

Favorable seasonality each year usually lasts until early May, but not always.

‘Don’t fight the Fed’, a positive when the Fed is increasing its easy money, becomes a decided negative when the Fed begins to pull back the punch bowl, and that could take place between now and March.   

The Fed is concerned that it has continued its stimulus for so long it risks creating dangerous asset bubbles, and needs to begin removing the punch bowl by tapering it back. Some analysts claim there are already bubble-like conditions showing up in the likes of investor enthusiasm and valuation levels, and expect the tapering to begin at the Fed’s December FOMC meeting.

But the Fed has also provided assurances it will not taper until the economy is strong enough to stand on its own feet.

This week’s economic reports indicate the anemic recovery has still not reached that point.

In the important housing industry, Pending Home Sales unexpectedly declined in October, for the fifth straight month, falling to the lowest level in 10 months. (The consensus forecast had been for an increase of 1.0%). The S&P/Case-Shiller Home Price Index showed home prices were up only 0.7% in September, the smallest amount since last February. Permits for future housing starts were up 6.2% in October. But unfortunately, that was almost all due to a big 17% increase in permits for apartment complexes, still in greater demand than single family homes thanks to the anemic economy. Permits for single family homes, considered to be the important criteria, were up less than 1%. And the Mortgage Bankers Association reported mortgage applications have fallen by 7% over the last four weeks.

The Dallas Fed’s Mfg Index fell again in November. It was at 12.8 in September; fell to 3.6 in October, and now to 1.9 in November. (The consensus forecast was for a bounce back to 5.0).

Last but not least, the Conference Board's Consumer Confidence Index, which unexpectedly plunged from 80.2 in September to 72.4 in October, fell further in November to 70.4. (The consensus forecast was for an improvement to 72.6).

If the Fed meant what it said about not tapering until the economic recovery improves enough to handle it, it will not begin tapering until next February or March.

So, favorable seasonality ends in April, and the Fed is likely to be reversing to the negative side of ‘Don’t fight the Fed’ by then.

Let’s hope the market doesn’t begin anticipating the end of those influences in advance of them taking place.

But it looks like Wall Street and corporations are preparing for that possibility.

When Wall Street and corporations become concerned that a serious market top may be approaching they try to get as much additional money as possible from investors while investors are still confidently buying. So there is usually a sizable increase in the number of initial public offerings (IPO’s) of stock in previously private companies and start-ups, as well as ‘secondary’ offerings of additional stock by established public companies.

So far this year there has been $51 billion of new IPO’s, the most since $63 billion in the same period in 2000, when that market bubble was beginning to burst. And there has been $155 billion in secondary offerings, more than near either the 2000 or 2007 tops.

Still more reasons to be careful and to realize that 2014 is not likely to be anything like 2013.

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Sy is president of StreetSmartReport.com and editor of the free market blog Street Smart Post. Follow him on twitter @streetsmartpost. He was the Timer Digest #1 Gold Timer for 2012 (Gold Timer of the Year), as well as the #2 Long-Term Stock Market Timer.