Whenever investors see bullish stock markets in a period of economic uncertainty, it's only natural to wonder whether a reversal of fortune is looming. Such is the skepticism surrounding the gains in Canadian stocks during the summer and early fall – which were not only impressive given the economic climate, but also bucked the long-term trend of seasonal sluggishness.
Having emerged unscathed from one of the traditionally roughest periods for markets (September-October), stocks are now entering the year-end period that historically has delivered strong returns. But given the gains we've already seen in a normally weak period, is it reasonable to expect that stocks can add to those gains in the coming months? Or is what went up poised to come down?
On the basis of the underlying fundamentals, that's a complicated and certainly debatable question. But at least from a historical standpoint, there's little reason to think a party that began in the usual summer-doldrums period can't rage on into the winter.
Bought in October? It's not over
In a report this week, UBS Securities Canada Inc. strategists George Vasic and Garry Cooper noted that the S&P/TSX composite index's 7.8-per-cent gain from the start of June to the end of October was its ninth-best performance in that period in the past 55 years. Usually this period – for which the trading axiom "sell in May and go away" was coined – is, at best, uninspiring, averaging a 1.2-per-cent decline since 1956.
It's worth noting, though, that this period has still generated positive returns in half of those years, and has been more likely to rise more than 5 per cent (19 times) than decline more than 5 per cent (15 times).
It's those occasions when the June-October returns exceed 5 per cent that provide the historical precedent for this year.
Mr. Vasic and Mr. Cooper found that, far from paying for those gains with weak performance in the subsequent months, those June-October rallies have consistently continued into the following November-to-May trading. The average gains have been an impressive 10.3 per cent, and the market has risen on 17 of those 19 occasions.
Fundamental flaws
It makes sense that, in general, a rallying market in the summer and fall would continue to rally in the winter and spring. Stocks trend higher in the vast majority of years, and in the years when the market is rising you'll tend to find positive returns in any given chunk of the calendar. Add to that the fact that investor buying tends to intensify toward the end of the calendar year (many big institutional investors have an Oct. 31 fiscal year end, so they'll often sell to lock in gains before Oct. 31 and step up their buying as their new fiscal year begins), and you have some compelling reasons to expect stocks to rise once November arrives, regardless of what happened before.
But there is a potential fly in the ointment this time: The fundamentals behind the May-to-October gains are hardly solid.
Certainly, the market was been helped in recent months by rising commodity prices – since resource-based stocks account for nearly half of the S&P/TSX composite index, by weighting. Whether those gains can be maintained, if and when the sliding U.S. dollar (the key impetus of the commodity gains) finds its footing, is another question.
Meanwhile, with the recovery sputtering in Western economies and emerging markets showing evidence of moderating, the potential for demand growth over the coming months doesn't look as good as it did a few months ago. That could weigh on commodity prices and corporate profits – and make a winning November-to-May a lot less certain than the historical statistics might suggest.