Market’s potential problems could make for a wild ride

With summer waning, market watchers are warning investors to buckle in for a bumpy ride this fall.

“There are lots of challenges out there right now, and we would expect market volatility to pick up,” said Kate Warne, an investment strategist at Edward Jones.

Acknowledging a respectable 12% gain by the S&P 500 so far this year, Ms. Warne said stocks are benefiting less from good news than from a lack of new bad news.

“It's the lack of surprises this year that has led to better stock performance and lower volatility,” she said. “But while Europe seems to have been on vacation, those troubles have not gone away.”

The list of factors expected to rattle investors include an economic slowdown in China, continued turmoil in the Middle East, a recessionary environment in Europe, the potential negative effect on the U.S. economy of the looming fiscal cliff and a presidential election now in a statistical dead heat.

“I'm forecasting an extended period of trendless volatility,” said Kevin Mahn, president and chief investment officer of Hennion & Walsh Asset Management Co., which has nearly $500 million in assets under management and supervision.

EASING INTO EASING

“As the election gets closer, we will start seeing market moves as a result of which party is [seen as] likely to win and gain control of Congress,” he said.

“I believe Greece will start the process to exit the euro this fall, and if Europe takes the market by surprise, you could see some dramatic market moves.”

One issue that has been taken off the table, at least for the time being, is another round of quantitative easing.

In a speech at Jackson Hole, Wyo., last Friday, Fed Chairman Ben S. Ber-nanke said that no immediate monetary action is being considered.

But Mr. Bernanke left the door open for later monetary action by the central bank if needed.

He also indicated no changes in plans to keep the federal funds rate near zero until at least the middle of 2014.

SEASONAL PATTERN

The back end of the adage about selling in May and going away for the summer means that market activity will pick up in September.

This helps explain the increased volatility that since 1964 has resulted in 17 stock market declines of 10% or more during September and October.

"“If you knew nothing else about the market, you know to sell in May and come back after Halloween, because there is a seasonal pattern of volatility that tends to be higher in October — and not for good reasons,” said Brian Gendreau, a market strategist at Cetera Financial Group Inc. and professor of finance at the University of Florida.

Stock market volatility, as measured by the Chicago Board Options Exchange Market Volatility Index, or VIX, has been trending downward since May, suggesting a certain degree of complacency in the market, he said.

The VIX, which since 1990 has averaged 20.5, is hovering around a five-year low of 16.7.

“The reason volatility tends to go up in September and October is because that's when the financial crises tend to occur. But this is an election year, and that changes everything,” Mr. Gendreau said.

“Every election year from 1900 through 2006, the market [went] up on trend through August, and then declined in September and October ahead of the election, and then [went] up again after the election.”

If history is any guide, it is safe to say that the stock market likes presidential election years.

Of the 45 presidential election years since 1833, 30 have been positive for the Dow Jones Industrial Average, according to Jeff Mortimer, director of investment strategy at BNY Mellon Wealth Management.

Breaking it down further, Mr. Mortimer pointed out that in each presidential election year since 1948, the third quarter has been the worst for stocks, with the Dow averaging a gain of just 40 basis points.

HAPPIER ENDING

The fourth quarter, however, usually represents a rebound, with the Dow averaging a 2.3% gain during those same election years.

Meanwhile, wary financial advisers are waiting for the storm to begin.

“Market volatility could be substantial over the next couple of months, and most of it will be the result of external events in places like Iran, Greece and Spain,” said Frank Trotter, chief executive of EverBank Wealth Management Inc.

“What we're seeing right now is event-driven attention deficit, where investors are focused on the next week or month, rather than how it fits into the big picture,” he added.

“For example, China is clearly on a path to decelerate, and the situation in Greece has not improved at all,” Mr. Trotter said.

“But we haven't been hearing about it lately, so investors are less worried about it.”

TIME OF UNCERTAINTY

Mr. Mortimer agreed that investors need to be prepared for market gyrations but said that BNY Mellon won't change any long-term allocations based on a couple of months of choppy trading.

“If you wait for the skies to clear and for everything to get fixed, the stock market will be much higher,” he said.

“The time to invest is when there is some uncertainty, and sometimes you have to take those positions when things are a little uncomfortable.”

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