Seasonal Tailwind: Q4 Equity Returns

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Seasonal Tailwind: Q4 Equity Returns

Today we want to build on our recent seasonal US equity volatility analysis to see what it signals for the S&P 500’s performance in Q4 2021. The S&P was up +20.4 pct YTD through August before this month, well over one standard deviation from the average since 1980. In our last note, we showed what happens in the notoriously choppy month of September during similar years of particularly strong returns. History says that the more positive the price momentum going into September, the less the S&P tends to fall in that month.

That played out this year, as the S&P 500 is down 1.8 pct this month with just 3 trading days left, close to the 0.7 pct average decline during previous especially strong years like 2021. That compares to the 2.6 pct average drop during any year when the S&P was down heading into September or the 5.0 pct average fall in particularly weak years.

With many investors still worried about a volatile October, what can history tell us about S&P returns for next month and November/December?

Three points on this:

#1: The S&P, on average, has done better in October (+1.1 pct) versus September (-0.6 pct) since 1980. The index’s returns have also been positive during a greater share of years in October than September (63 pct versus 49 pct).

Moreover, the index typically performs well from the last day in October through year-end (+4.3 pct on average) and has been up during 80 pct of years in November-December since 1980.

Takeaway: the last 4 decades of market history show that, on average, October not only recoups September’s losses but adds to the year’s gains. Moreover, the remainder of the year tends to continue October’s bullish bias.

#2: Momentum plays a role in how the S&P performs in October, with a clear difference in the historical data after positive or negative returns in September:

  • During the slightly more than half of years when the S&P has performed negatively in September (-4.0 pct negative return, on average) since 1980, the S&P has had an average return of +0.8 pct in October. It’s also gained +2.7 pct in November and December to finish out the year.

    Note: we recognize that down 4.0 percent average is a large mean drawdown, but that’s due to major events, such as the Dot Com Bubble Burst, Greek Debt Crisis and the Financial Crisis. Here were the 5 worst years: 2002 (-11.0 pct), 2008 (-9.0 pct), 1986 (-8.5 pct), 2001 (-8.2 pct) and 2011 (-7.2 pct). Excluding those outliers, September’s down years averaged -2.5 pct, which was followed by +0.4 pct and +3.4 pct in October and November/December.
  • During the nearly half of years when the S&P has performed positively in September (+3.0 pct on average), the S&P has returned +1.4 pct in October and +3.9 pct in November and December.

Takeaway: the S&P performs better in October and the last two months of the year when it heads into those months with a positive rather than negative September return (notable because we’re still down in September 2021).

#3: Lastly, let’s look at the six years with especially robust YTD returns through August (1 standard deviation above the mean). Here is how the S&P performed in Q4 after being down an average of 0.7 pct in September during those years:

  • 4 years were down in October: 1987 (-21.8 pct), 1989 (-2.5 pct), 1995 (-0.5 pct) and 1997 (-3.5 pct). Two years were higher: 1986 (+5.5 pct) and 1991 (+1.2 pct).

    The overall average was -3.6 pct, or flat (0.0 pct) when excluding the outlier of 1987.
  • During November and December, 4 years were higher: 1989 (+3.7 pct), 1991 (+6.4 pct), 1995 (+5.9 pct) and 1997 (+5.9 pct). Two were lower: 1986 (-0.8 pct) and 1987 (-1.5 pct).

    The overall average was +3.3 pct.

Takeaway: during particularly strong years for the S&P from January to August, returns are about flat in October (excluding 1987) and higher the balance of the year.

Bottom line: we are bullish on rest-of-year returns for US large cap stocks, but history says it may be challenging to keep the faith during October. This has been an unusual year, both in terms of excellent YTD returns but also in the atypical nature of the current economic recovery. What sort of “Recovery Year 2” has supply chain bottlenecks and labor/materials shortages? As positive as we are on Q3 earnings, which will be reported in October, the worse-than-coin-toss odds of an up month (point #3) after already strong YTD returns tells us to be cautious over the very near term.