Skip to main content
  • Redemptions may be a headwind in July.
  • Stocks usually perform poorly in August and September.
  • Waiting for conviction can improve your risk/reward.

July is a strong month for stocks, but its track record in midterm election years is mixed. For example, the S&P 500 index gains 0.9% in July during midterm years, but returns for the NASDAQ and Russell 2000 indexes are negative, according to the Stock Trader's Almanac. The poor performance coupled with slowing economic growth, a hawkish Fed, and a potentially disappointing earnings season suggests you may not want to extrapolate 'typical' seasonal strength too far into the future.

So far this year, that kind of pessimism has paid off. While stocks have a seasonal tendency for upside at the end of a month and the start of a new month, and that tendency increases because of pension fund asset allocations at the end of a quarter, each end-of-month rally has fizzled out quickly this year. We saw that happen following big rallies in January, February, March, and May and after April's tepid rally attempt.

CHART-Street-Smarts-0630

Indeed, anything is possible, but given this year's track record, I'd rather wait patiently for conviction than guess seasonal tendencies will produce a long-lasting rally.

Ignore short-term gamesmanship

Retirement contributions provide an upside bias in the final days and the first few days of a month. It's also true this bias can be stronger at the beginning of a new quarter because of pension fund asset allocations. For instance, Goldman Sachs estimates $30 billion could head toward equities because of rebalancing this year. Mutual fund and hedge fund gamesmanship can also cause a final day pop that can carry over into the first few trading days.

However, it remains to be seen if end-of-quarter statements prompt a wave of redemption letters despite managers' best window-dressing efforts; and if managers sell strength to raise cash in anticipation of those redemptions. As the saying goes, it's better to sell when you can, not when you have to.

The S&P 500 is down nearly 20% year to date, making it the index's worst start since 1970. The NASDAQ and the Russell 2000 are down more, falling 28% and 24% year-to-date through Wednesday. Active investors won't be surprised by those returns, but many Main Street investors could be shocked when they open their second-quarter statements. If so, phones may start ringing with instructions to reduce risk (I saw this first hand during the Internet bust).

Also, you can bet those who invest in hedge funds, including fund-of-fund managers, pension managers, and insurers, are reviewing every one of their managers. As a result, many funds could see their allocation cut, especially growth managers whose performance is likely significantly worse than the market. Instead of doubling down with those managers, rebalancing inflows may go to defensive stocks, particularly given where we are in the business cycle.

On Thursday, we learned that inflation is still too high and that the Atlanta Fed's latest second-quarter GDP forecast is negative 1%, down from 0.3% earlier this week.

Inflation has been increasing faster than wages for over a year, and consumer spending is shifting from discretionary purchases to necessities. This shift makes it harder for companies to pass along their rising costs, pressuring operating margins and profit. As a result, more companies could reduce their earnings outlook when they report second-quarter earnings over the next two months. If so, a recalibration of valuation models could create additional selling this summer.

The Smart Play

Historically, early July strength starts fading mid-month, and that weakness usually continues into August and September. 

According to the Stock Trader's Almanac, August is the 10th worst performing month of the year for the S&P 500 and the 11th worst month for the NASDAQ since 1950. Additionally, in midterm election years, the S&P 500, NASDAQ, and Russell 2000 historically post a negative average return in August and September, which is the worst month for historical performance.

The takeaway? If we see strength in the first few days of July, it may benefit you to be wary.

Of course, historical tendencies don't repeat exactly, and exceptions can exist. For example, suppose commodity prices decline sharply, and inflation falls. In that case, the argument the Fed abandons hawkish policy, allowing stocks to put in a bear market bottom, strengthens, especially if declining GDP causes unemployment.

That's guesswork, though.

If you're a short-term trader, it could be best to wait for data that supports the argument for a friendlier Fed. Yes, you may be able to scalp profit long and short this summer, but keeping those profits may be challenging if markets are choppy. Bear market rallies are born on short covering but mature on institutional buying. So far, multiple bear market rallies have been born, but there's been zero institutional follow-through.

Up until now, buying when sentiment is horrible and selling when stocks meet resistance at moving averages has worked. I suspect that remains true for a bit longer. But, I worry too many are taking on too much risk playing that game, especially with illiquid, high-beta stocks. Instead, it could wise to exercise your patience muscle.

If you're a long-term investor, there's never been a period when Dollar-cost averaging into the S&P 500 during a bear market hasn't eventually paid off. Although stocks are off to their worst start since 1970, it's important to remember that the S&P 500 is significantly higher today than it was back then.

Given the challenges ahead, jumping off the horse midstream may be tempting to protect yourself short term. However, getting back on the horse in time to capture big gains when the bulls regain the field is mentally tough. For this reason, my advice for next quarter is unchanged: Dollar-cost average into a major market index, such as through a workplace retirement plan, so that you own more shares at a lower average cost when the bear market ends.

  • Redemptions may be a headwind in July.
  • Stocks usually perform poorly in August and September.
  • Waiting for conviction can improve your risk/reward.

July is a strong month for stocks, but its track record in midterm election years is mixed. For example, the S&P 500 index gains 0.9% in July during midterm years, but returns for the NASDAQ and Russell 2000 indexes are negative, according to the Stock Trader's Almanac. The poor performance coupled with slowing economic growth, a hawkish Fed, and a potentially disappointing earnings season suggests you may not want to extrapolate 'typical' seasonal strength too far into the future.

Member Exclusive

Get a daily dose of TheStreet’s smartest insights from its smartest analysts.

Do-nothing_2

Stocks: The Argument for "Doing Nothing"

History suggests that long-term investors are best off sitting on their hands, rather than taking action based on short-term news.

Energy-Stocks (3)

Should You Be Buying Energy Stocks?

The best days may be behind oil stocks, but there could be a short-term trading opportunity.

Bad-News-Good-News

When Bad News Becomes Good News

Bad news during bear markets can feel unbearable, but remember markets bottom when the news is worst.