Summer calm could give way to stock shock

Forecasters predicting unusually choppy equity markets; 'extended period of trendless volatility'

Aug 30, 2012 @ 12:01 am

By Jeff Benjamin

Enjoy the last few days of August, then relax over the Labor Day weekend. Better yet, go to an amusement park. The visit should help prepare you for what stock market watchers say is coming this fall.

Indeed, financial advisers, money managers and market experts are generally bracing for what could be more than the usual market volatility that tends to increase during September and October.

“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 under management and supervision.

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

“As the election gets closer we will start seeing market moves as a result of which party is likely to win and gain control of Congress,” Mr. Mahn added. “I do 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.”

The back end of the adage about selling in May and going away for the summer means more market activity starting in September.

This helps explain the increased volatility that has since 1964 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, 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, according to Mr. Gendreau.

The VIX, which since 1990 has averaged 20.5, is currently 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 since 1948, the third quarter of a presidential election year has been the worst for stocks, with the Dow averaging a gain of just 40 basis points.

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

For some financial advisers, this is the calm before the storm.

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

Mr. Mortimer agreed that investors need to be prepared for volatility, but said that BNY Mellon isn't changing 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 way 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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