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Does the Dow’s 9-Month Sprint Mean It Will Tire in the Fourth Quarter?

Michael Santoli

When a horse is leading into the home stretch, it can mean it's just hitting its stride or is about to tire. Same with the stock market as October approaches.


And it turns out it's been slightly more common to see some fatigue set in than for momentum to build further.

The Dow is on track to post its ninth-best run through the first three quarters in the past 50 years. History suggests the odds are better than average for a bit more upside in the final three months – but the results are not quite as strong as in years when stocks have risen less through September.

The Dow’s total return (including dividends) is on track to finish this last session of the third quarter up between 15% and 16%. The index has returned at 15% or more through September in only eight prior years in the last half-century, the last time in 1997.

Up five, down three

According to a historical screen run upon request by Schaeffer’s Investment Research, in those previous eight years when a 15% gain had built up, the fourth quarter was up five times and down three, with a median return of 1.77% from October through December. That’s a bit weaker than the general tendency over the past 50 years, which saw gains in the fourth quarter 74% of the time, with a median return of 2.79%.

As with so many studies of historical market behavior, the extreme experience of 1987 skews the data a bit. The record one-day crash in October ’87 meant the Dow in the fourth quarter that year was down a bruising 25.3% (including dividends). This, in fact, drags the average return for the fourth quarters that began with at least a 15% year-to-date gain slightly into negative territory.

Of course, that year the Dow had roared higher by more than 40% by the time of its August peak, and was contending with a year-long squeeze of rising interest rates driven by both the Federal Reserve and the bond market.

Still, even excluding 1987, the market has done OK but slightly worse than average when up as much as 15% to start October, according to Schaeffer’s. In fact, the sweet spot seems to be when stocks are up nicely but less than 15% in the first three quarters. When the Dow was up at least 10% but less than 15% by Sept. 30 (which occurred 18 times), the rest of the year was higher 72% of the time for a median rise of 3.75%.

None of this almanac work rises to the level of airtight statistical significance, given such a small sample of 50 instances. But the data imply that, when stocks are up near 10% over nine months, there is a positive underlying trend but not as much front-loading of potential future returns.

Such seasonal and historical tendencies are better seen as the market climate rather than weather. There has probably never been more attention on such factors, which used to be monitored and discussed only among a narrow cohort of professional and technical market handicappers. Arguably, this has diluted their value, as traders anticipate and potentially “trade away” such anomalies.

'Sell in May' could hold up

It’s become common to insist, for instance, that this year the old “Sell in May” rule of thumb was a bum steer, given that the June selloff was reversed and the indexes made new highs in August and September. Maybe so, but all that rule really says is that the majority of upside over time has been registered from November through April, which has held true in the past year. And given that the May high in the Dow of 15,409 is a couple of percentage points above today’s level, an investor has hardly been penalized much for having scaled back on stock holdings before Memorial Day.

On the other hand, September’s notorious hazards, given it is by quite a margin the weakest month of the year through the ages, were not in evidence in 2013. In fact, the 4.5% August tumble was arguably a matter of the feared September setback experienced a month early, largely reversed by the past few weeks’ recovery. Today, of course, the indexes are seeing some red as investors prep for a possible government shutdown, with a midnight deadline looming.

Whatever the outcome of the Washington budget trench warfare and debt-ceiling bar fight, Wall Street consensus seems to be that they are excuses for some more near-term skittish stock action – but that this will ultimately give way to relief and the standard upside bias in November and December. Maybe so. It certainly has not paid to await a serious, lasting pullback so far this year.

But the question for anyone preaching for the “usual year-end rally” remains: “From what level?”