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What October Pullback May Lead to for Stock Market Investors

The S&P 500 Index (“S&P 500”) has decreased over 5% thus far in October (though still higher year-to-date thus far in 2014) as I write this post.   Many investors have been long awaiting this type of a market pullback before feeling comfortable adding allocations to equities.  As a result, we researched previous monthly market pullbacks to see how the stock market reacted in the two months following these monthly market pullbacks to gain a sense of what may happen for the final two months of 2014 if, in fact, October closes with a monthly “pullback” in the range of 5% – 10%.

Using data from Bloomberg, we analyzed nearly 24 years of returns for the S&P 500, starting from December 30, 1990 and ending with August 31, 2014.  Over this timeframe, the S&P 500 experienced a monthly market pullback 22 times – or less than 8% of the time.    Interestingly, the S&P 500 finished higher:

  1. 41% of the time for the following month
  2. 55% of the time for the second following month
  3. 55% of the time for the cumulative return of the two months following

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According to this study, market returns for the two months following a monthly market pullback were, on average, essentially flat.  However, if the current downturn in October (which is often noted as being one of the more volatile months on the stock market calendar) enters the “correction” territory by exceeding a monthly loss of 10%, the outlook for stock market investors may be even rosier based upon the results of this particular historical research study.  Over this timeframe, the S&P 500 experienced a monthly market correction (i.e. a decline in stock valuations between 10% – 20%) 4 times – or roughly 1% of the time.    During these instances, the S&P 500 finished higher:

  1. 75% of the time for the following month
  2. 100% of the time for the second following month
  3. 75% of the time for the cumulative return of the two months following

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It is important to note that past performance does not guarantee future results and the market may react very differently in 2014 than it did during these previous monthly market pullbacks.  Our study also did not necessarily observe the market reaction of pullbacks or corrections that may have occurred within the course of a month or over the course of several months, as the study just looked at monthly periods.  Regardless, the statistics are compelling and should not be disregarded entirely.

Given the gradually firming foundation of our U.S. economy, the difficulties currently being experienced within other international market economies and the activist nature of the Federal Reserve (“Fed’), we find more rationale to support further upside potential in the U.S. stock market than a significant market downturn.  In this regard, it may be helpful to remember, on days when short term volatility spikes upward, that the Fed recently reported a modestly improving U.S. economy citing a falling unemployment rate, increased household spending and increased business investment.  In addition, third quarter corporate earnings are expected to increase at a pace of 4.6% according to the Business Insider article entitled, “Earnings Season is Kicking Off, And Analysts Have Already Slashed Their Expectations”, 2nd quarter Gross Domestic Product (“GDP”) was revised higher to show an annual growth rate of 4.6% for the second quarter according to a Forbes article entitled, “U.S. GDP Grew 4.6% in Second Quarter, Up from Earlier Estimates” and yields on U.S. Treasuries move lower as certain investors seek safe havens, encouraging income-oriented investors to consider dividend paying stocks.    Hence, there are valid reasons for forward looking optimism in our view for investors.  Other market cycles, such as the upcoming midterm elections (which will be discussed in a separate, upcoming blog post), may bode well for U.S. stock market investors as well as we head towards the investments finish line of 2014.

Despite this longer term optimism, we do not dismiss the potential for additional, intermittent periods of stock market volatility over shorter term durations.    However, absent any geopolitical/global macro shocks that may take place, it is hard to imagine a market pullback extending beyond the 5% – 10% range given all of the institutional and retail cash that is currently sitting on the sidelines.  This cash (currently sitting in asset types such as money market funds) is likely to be positioned back into the market, in our opinion, once this pullback occurs.   This cash infusion,  along with the underlying solidifying fundamentals of this economic recovery, should help propel the next cycle of this secular bull market run.   As a result, we, at Hennion & Walsh, feel that an appropriate investment strategy for this outlook would be to create (or maintain) a diversified, growth portfolio that could help investors navigate through a short-term market pullback while still being positioned for the next leg of this bull market cycle.

Disclosure:  Our views on the stock market cycles discussed in this piece are for educational purposes only and should not be considered as a solicitation to purchase or sell any of the strategies mentioned.  According to S&P Dow Jones Indices, the S&P 500 index is widely regarded as the best single gauge of large cap U.S. equities. There is over U.S.D 5.14 trillion benchmarked to the index, with index assets comprising approximately U.S.D 1.6 trillion of this total. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization. You cannot invest directly in an index.