November’s Pain Could Be December’s Gain

by Daniel Putnam | November 14, 2012 12:08 pm

Things may not be looking so good right now, but there’s still hope for the near future. Why? Well, a negative return for the S&P 500 Index from Halloween to Thanksgiving usually signals strong performance for the remainder of the year.

From 1950 to 2011, there were 21 instances in which the S&P 500 produced a negative return from the end of October through the Wednesday before Thanksgiving. On 17 of those occasions, the market registered a gain the rest of the way. The Thanksgiving to New Year’s rally resulted in a 2.68% return for the index on average — well above what could be expected in a typical month. On the occasions in which stocks failed to rally, the downturns were fairly benign.

With this in mind, a profitable trade may be on tap for those willing to go against the grain.

A look at the individual numbers shows that the stock market has been surprisingly resilient in the post-Thanksgiving period even under adverse circumstances. While there was no year-end rally in either year of the 1973-1974 bear market, stocks managed to produce a gain in the years of the Kennedy assassination, the 1987 stock market crash and the 2007-2008 financial crisis.

Year S&P Return,
S&P Return,
1951 -1.31% 6.12%
1953 -0.08% 0.61%
1956 -2.00% 3.39%
1959 -0.14% 3.80%
1963 -2.38% 2.44%
1965 -0.52% 0.43%
1969 -3.96% -1.87%
1971 -2.66% 11.04%
1973 -7.88% -1.90%
1974 -5.36% -2.02%
1976 -0.48% 4.18%
1984 -0.95% 0.19%
1987 -3.05% 2.80%
1988 -3.57% 3.93%
1991 -4.05% 11.16%
1993 -1.02% 0.73%
1994 -4.75% 1.54%
2000 -7.49% -1.60%
2007 -8.56% 1.92%
2008 -8.37% 0.78%
2011 -7.30% 8.54%
Average   2.68%

Trading based on seasonal patterns is a dangerous game, as each year brings its own set of circumstances. This year, of course, the concerns about the fiscal cliff have been the key factor driving market performance. At first glance, it seems unlikely that the market would be able to gain any post-Thanksgiving traction ahead of the year-end deadline for the cliff’s resolution. A parallel situation occurred in 2000 when the prospect of Y2K-related chaos prevented the usual year-end rebound from taking place.

Given the tremendous amount[2] of discussion about the issue in the past week, however, the risk-reward equation has become asymmetrical. While surprising progress could bring some meaningful upside to the market, the prospect of legislators’ failure to address the cliff is already being priced in. In this regard, it’s interesting that fiscal cliff  “countdown clocks” have begun to pop up in the financial press — most notably on CBS MarketWatch and periodically on the CNBC network. As veteran investors know, major market meltdowns typically come from surprises, and not from events that are accompanied by countdown clocks.

It’s difficult to fight the sell-off when headline risk is so high, but history has shown that the current set-up — with the S&P 500 already down nearly 3% so far this month — may in fact be an opportunity for a profitable contrarian trade.

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