With the summer near end and the kids back in the classroom (unless you’re in BC) investors are looking to the latter four months of the year to see how 2014 will shape up. The TSX has enjoyed solid returns year-to-date, up over 14% since the start of the year, which is the best performance we have seen from the index since 2009. When we remove 2009 from the equation, which had the significant advantage of picking of the pieces of a 35% decline in the previous year, we would have to go all the way back to 2005 to find an 8 month period from January to September that was as astoundingly profitable for investors.

But right now, there is a bit of a debate surrounding the markets about whether or not they are primed for a correction. Many expected to see a full force correction in the summer but to their surprise, the market largely chugged forward. With the summer now beyond us, look to the fall for a possible pullback.

There is also some discussion that September and October are notably poor months for the market. There is even a theory called the “October Effect” which states that stocks tend to decline in the month of October. At KeyStone, we always urge investors to look at the markets from a long-term perspective and warn against employing seasonal strategies. But from a purely informational perspective, it is always a little fun to go back through time and size these proclamations up against actual statistical evidence.

The table below provides month’s percentage price returns for September and October over a 10 year period from 2004 to 2013.

What this data tells us is that from a historical perspective (at least over the last 10 years), the months of September and October actually produce good returns, with both months ending positive in 7 out of 10 years. Now this isn’t to say that history will repeat itself in 2014. We have enjoyed very solid returns through the summer in absence of strong economic data which would indicate that the market may be poised for a healthy correction. But the next time you hear someone talk about September and October being bad times to be in the market or the “October Effect,” you will know that the proclamations are not backed up by the data. 

KeyStone’s Latest Reports Section

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In The Money Bubble: What To Do Before It Pops, James Turk and I climb out on a some very long limbs with a series of extreme predictions. This series of posts will track the ones that are (or seem to be) working out, beginning with increasingly wild swings in US equities:

Chapter 26, page 294:
For a sense of how an over-indebted financial system enters a catastrophic collapse, imagine a spinning top. For a while after being set in motion, the top stays in one place, spinning smoothly. But then a slight wobble creeps into its rotation, gradually becoming more pronounced until it turns violent. The unstable top then shoots off in a random direction to crash against whatever is nearby. That’s how the financial markets will behave when the Money Bubble bursts.

As this is written in late 2013, our imagined top is spinning smoothly again after a huge, near-catastrophic wobble in 2008. With US stock prices at record highs, interest rates still historically low and daily fluctuations in major markets reasonably muted, all looks well. But soon, probably in 2014 but almost certainly by 2015, the fluctuations will begin to increase until the system spins out of control.

Now consider the US stock market over the past two weeks. The following table lists the daily fluctuations of the Dow Jones Industrial Average where in the space of ten trading days there have been seven triple-digit moves, for an average swing of 132 points. Mr. Market’s mood swings are getting more and more violent.

A useful indicator of where the markets are in this process is the VIX index of volatility in the S&P 500 options market, which

predicts month-ahead fluctuations in the stock market. Figure 26.3 shows how placid the US stock market, as depicted by its low volatility, was while the housing bubble was inflating in the mid-2000s. But notice what happened in 2007 and early 2008: First came some wobbles, as the early indications of a bursting housing bubble hit the markets. Then in 2008 the bubble burst and the banking system began to implode. The markets were terrified and capital was pouring in and out (mostly out) of stocks and pretty much every other financial asset class, causing wild fluctuations. The VIX soared from 20 to 80 in a matter of months.

In late 2013 the top was once again spinning smoothly. But under the surface, all the imbalances that nearly destroyed the global financial system in 2008 were not only still resent, they were being amplified by governments around the world borrowing aggressively, printing, and intervening. By late 2013 the system was once again primed to start wobbling. Which means a spectacular trade is just waiting to be placed.

So the follow-on prediction is that today’s volatility, like that of 2007, will be resolved to the downside via a market crash and possibly a full-blown financial crisis sometime in the coming year. Stay tuned.

What a difference a week can make. Recall it was just two weeks ago tomorrow, Friday, Sept. 19, when the Dow Jones Industrial Average closed at a fresh, record high of 17,350 … but it has been a stomach-churning rollercoaster ride ever since with volatile whipsaws along the way.

Last week the Dow posted triple-digit gains or losses every single trading day, and the turbulence continues into this week, leaving investors with a bad case of whiplash and pondering what comes next.

It’s hard to pin down the exact reason for the market turbulence. Worries about Russia, Ukraine, Syria, ISIS, China, interest rates … take your pick. But the truth is none of this is really new; these events have been background noise for months now as global stocks kept moving higher.

Perhaps the return of higher market volatility is simply to be expected at this point. After all, September and October have historically been some of the most volatile months of the year for markets.

September and October can be scary for investors, but often produce buying opportunities

So here’s the key question: Is this just another temporary selling-squall that will soon blow over, or is there a bigger storm brewing for stocks?

To help answer that question, let’s review the seasonal trends and where we are now in the stock market cycle. A closer look at the evidence suggests a buying opportunity may be just around the corner.

As shown in the chart below, September has historically been by far the worst month to be invested in stocks. And October has the fourth-worst monthly performance.

September is the only month of the year that is down more often than it’s up, falling 45 percent of the time since 1928, and posting an average loss of 1.1 percent. This year was a bit below average, with the S&P 500 falling 1.5 percent last month.

A correction could be just what you’ve been waiting for

The good news: While September and October have a well-deserved bad reputation for some nasty market selloffs in the past, more recently stocks rallied during the month of September in three of the past five years.

But in spite of the September swoon, there’s a very good reason for optimism: We have just entered the seasonal sweet-spot for stocks!

The stock market and broader economy tend to follow cycles. And it’s uncanny how often these patterns repeat, not every year mind you, but often enough to profit. And perhaps the most powerful pattern of all is tied to the four-year election cycle in the U.S.

Right now we’re in the mid-term year (or year #2) of the four-year Presidential Cycle. Based on almost a century of data going back to 1928, this cycle hits a bullish peak from September of the mid-term election year (right now) through August of year #3.

This stock market cycle offers triple the average profit potential

The average return for the S&P 500 during this period is 19.6 percent, over just three-quarters of a year. This compares quite favorably to the average full year gain of just 7.5 percent for the S&P in all years — nearly three-times the upside potential!

In fact, the next three quarters are the three best consecutive quarters of the Presidential Cycle based not only on historical returns, but also the persistency of stocks rising.

* The fourth quarter of year #2, which began Wednesday, is up 86 percent of the time and posts average gains of 6.5 percent …

* First quarter of year #3 (Jan. — March, 2015) is up 81 percent of the time with stocks rising 5.7 percent on average …

* And the second quarter (April — June) is up 71 percent of the time with an average gain of 4.7 percent!

These results are well above the norm, almost three times better, than the 1.9 percent average quarterly gain for the S&P 500 going back to 1928!

Bottom line: Corrections are perfectly normal from time to time; they come with the territory. What is unusual is that we haven’t had more than a 10 percent pull back in stocks since 2012, so you could say we’re overdue.

But the most bullish phase of the four-year Presidential Cycle began yesterday, and there is plenty of upside potential ahead for stocks over the next few quarters.

If history is a guide, this correction should result in a wonderful buying opportunity for a year-end rally … that may continue well into 2015!

Good investing,

Mike Burnick

The first case of the lethal Ebola virus has been diagnosed in Dallas, Texas. It appears the man is believed to have contracted the virus in Liberia before travelling to the US nearly two weeks ago. Health officials say he is being kept in isolation. However, you can bet everyone on that plane was at least exposed. It does not appear that flying to Africa is a very good idea.

Cyclically, we are due for another plague. The Romans were great secretaries and tended to record events of this nature. When we analyzed the history of plagues, we found a strong correlation to Pi (π). The span of just the major plagues recorded by the Romans was 474 years divided by 6 events produces 79 and dividing that by Pi 3.14 gives us 25.15 years.

This is very close to the 8.6 frequency (3 x 8.6 = 25.8). Testing this frequency brought us to the Black Death/Plague of the 14th Century, the Great Influenza of the mid-19thCentury that killed many of my own family, the influenza of World War I, the Malaria epidemic of 1940, and the next target being 2019. Economically, the Black Death killed about 50% of the European population and created a shortage in labor. This resulted in altering the economy creating wages as landlords now competed for labor and serfdom came to an end in Western Europe (Russia continued into the 19th century).

It appears we have whatever can go wrong for civilization is going wrong. I always wanted to do one of those photo safari trips in Africa. It looks like that is not going to happen for a very long time.