Conversely, nearly all of the biggest late-year drops took place during the 19 instances when the S&P 500 started September in a downtrend, i.e., below its 200-day moving average (1987 was one big exception, falling as much as 32%). The average drawdown in these scenarios was 8.9%, about twice the average drawdown with the uptrend, while stocks were higher over the rest of the year only 57.9% of the time.
MORE REASONS TO HOLD ON
Valuations and the calendar may not be good reasons to sell, but are there, in fact, reasons to consider buying here? We have held our 2016 stock market forecast unchanged (mid-single-digit returns for the S&P 500 for the year), but a double-digit return year for stocks would not shock us, given these factors:
· Low recession odds. We continue to see the odds of recession over the next 12–18 months as being in the 20% range based on our favorite leading indicators and few signs of excesses in the economy that might lead to major imbalances. If a recession is more than a year away, based on data back to 1950, the odds are over 80% that the S&P 500 delivers a positive annual return.
· Central bank support and low interest rates. If the economy weakens further, the Federal Reserve (Fed) may deliver additional stimulus. The Fed could state its intentions to maintain low interest rates for longer, or potentially initiate another round of quantitative easing, i.e., more bond purchases. We do not like relying on these policies to prop up stocks, but the fact remains that markets have responded to them. Low bond yields continue to enhance the appeal of stocks.
· Earnings rebound. Future earnings estimates have tended to run high historically and are always subject to change; however, the economic data, along with stability in oil and the U.S. dollar, suggest an earnings rebound may be doable. Current earnings growth expectations based on Thomson Reuters consensus data for the fourth quarter of 2016 and first and second quarters of 2017 are +8%, +15%, and +13%. Remember, markets tend to look about six months ahead.
· Fourth quarter rally? The S&P 500 has historically performed well during the fourth quarter with an average gain of over 4% (versus a 2.1% average for all quarters), with gains 79% of the time going back to 1950. Fourth quarters of election years are no better than an average quarter, but excluding 2008, the average fourth quarter gain during an election year is 3.6% and the S&P 500 is higher 87% of those quarters. We continue to believe that markets should welcome greater clarity on the potential election outcome when it arrives.
CONCLUSION
Neither valuations nor seasonality appear to be good reasons to sell stocks right now. In fact, a number of factors we have discussed here suggest stocks could potentially go higher between now and year-end. We are sticking with our mid-single-digit return forecast for 2016, but don’t be surprised to see a pickup in volatility and consider the opportunity to buy those dips.*
Burt White is chief investment officer for LPL Financial.