Monday, July 24, 2006

August - Time To Go away

I mentioned that although the underlying fundamentals are strong for equities, we are probably not going to see a strong rally till mid-end of October. August is not a good month generally. Markets are about to move into what is typically the worst time of the year for stock investing: late summer and early fall (Western world view). The third quarter is also typically the worst quarter of the year for Wall Street. And those who follow the four-year cycle of the presidency will tell you that the second year of a presidential term of office, like 2006, is the worst of the four. Although, any year under Bush seems to be the worst to me.

How important are seasonal factors? Patterns are there because of some underlying factors, and as observers, we need to decipher whether those similar factors are repeating this year before we hold onto the rule of thumb. Investors are nervously eyeing the worst violence in years in the Mideast; oil prices are near record highs; worries about a slowing economy and rising interest rates in the US; and a possible slowdown in corporate profit growth is looming.

For the last 18 years, August has been the worst month of the year for the S&P 500, and the second worst month for the Dow Jones industrials and the Nasdaq composite.

2006 also marks the second year of the presidential cycle, and that's not a good thing. Over the last 60 years, the third quarter of year two has been good for an average decline of 2.2 percent on the S&P 500. Consider again the presidential cycle theory. The Dow has fallen 22.2 percent on average between the high it hit in the first year of the four-year cycle - such as 2005 - and the low it hit in the second year - in this case 2006. Even after the recent selloff, the Dow is only trading 1.8 percent below that 2005 high - suggesting that a much bigger drop is yet to come.

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