We continue to believe a late-year rally for stocks will fulfill our long-held outlook for modest single-digit gains on the year for the S&P 500. However, over the next month or two, the risk that the soft spot lingers and pulls the market back to the lows of the year is significant. Seasonal factors also favor caution given the historically weak performance in September and October. Since 1950, the month of September has more often led to a decline than a gain in the S&P 500 index. However, November and December have provided some of the best returns of the year, on average.
There are a number of potential catalysts for a fourth quarter rally:
1. At the Federal Reserve (Fed) Meeting on September 21, the Fed may announce additional stimulus measures to stimulate growth. On Friday of last week, in his speech from the Fed’s Jackson Hole symposium, Fed chairman Ben Bernanke seemed to pave the way for another round of monetary stimulus. Although he noted that the Fed needs to see more evidence of a slowing economy or further disinflation to act. Friday’s profit warning from a large Technology company is potentially significant in tilting the Fed towards easing should it be followed by a number of other companies in the coming weeks. The unemployment rate ticking up in the August employment report due to be released this Friday would move the Fed in the direction of more stimulus, as well. It may be unlikely the Fed will move as soon as a few weeks from now, there will be plenty of data released before the September 21 FOMC meeting that could show further softening of the economy, raising investor expectations for Fed action.
2. Positive pre-election policy discussions in Washington as incumbents seek to alter the tide of the popular vote — often termed an “October surprise”. In the weeks ahead of the November 2 mid-term elections, incumbents in Washington may take positive stances on issues that are market friendly. Incumbents are in trouble according to state and regional polling data. In seeking to turn the tide of voter sentiment they may talk about tax cuts or other issues favorable to stock market investors.