Sell in November and Go Away?

10/14/2010 1:30 pm EST

Focus: MARKETS

Howard Gold

Founder & President, GoldenEgg Investing

Just when you think you’ve got the stock market figured out, it throws you a curve.

September is supposed to be the single worst month for stocks, and yet this year stocks posted their best performance in that benighted month in seven decades.

And October, the time of ghosts, goblins, and stock market crashes, has continued September’s brisk advance.

Halfway through the month, the Standard & Poor’s 500 has risen almost 4%, closing Wednesday strongly at 1178.10. From their recent lows in late August, stocks have rallied 13%.

And now, as we enter not only the best season for stocks in the calendar year, but also the very best three quarters in the four-year election cycle, you’d think you should just sit back and enjoy the ride, right?

But I’m worried the market may be getting ready to throw us a screwball.

Three big forces behind the recent rise—earnings season, the midterm elections, and the Federal Reserve’s moves to print more money—may come together by early November to drive stocks to a near-term peak, and some profit-taking could follow.

And though I remain cautiously optimistic for the months beyond, we could be in for some nasty bumps in coming weeks.

Why? Because a lot of good news is factored into stock prices already.

First, corporate earnings. Intel (Nasdaq: INTC) reported stronger than expected third-quarter chip sales, driving technology and other stocks higher (although Intel itself was down.) And JPMorgan Chase (NYSE: JPM) also beat analysts’ estimates, as it set aside less money to absorb losses from bad loans.

Good earnings from corporate America were one of the three reasons I gave to be at least a little bullish back in early August. Employment stinks and small businesses are struggling, but multinational corporate America is in great shape—flush with cash and selling like crazy overseas.

The good news from the big blue-chip names will be rolling across the ticker over the next couple of weeks, but by the first week in November earnings season will be pretty much done.

That same week, of course, we’ll finally know the results of the midterm elections.

Everyone except House Speaker Nancy Pelosi expects the Democrats to take a shellacking amid voter anger about the economy and huge budget deficits. Video: Steve Forbes Predicts a Big GOP Sweep Ahead

Right now, the highly regarded prediction market intrade.com is giving Republicans an 87% chance of regaining control of the House of Representatives and a 74% chance of capturing at least 50 seats. Intrade also says that Democrats will barely maintain control of the Senate.

That prescription for gridlock and a sharp division of power between both sides of Pennsylvania Avenue is just what investors love, as it will likely mean few high-tax, big-government initiatives over the next two years.

But it also means that only a bigger Republican victory in the House (the Republicans picked up 54 seats in the Contract with America election of 1994) and maybe even a surprise GOP takeover of the Senate would be enough to power stocks higher once the results are in.

Next: The Fed’s Next Big Move

|pagebreak|

While the country is digesting the election returns, the Federal Open Market Committee will meet and announce its decisions by Wednesday, November 3rd.

Here again, investors expect the central bank to resume its policy of “quantitative easing”—printing money—to help jump start the sagging economy. Federal Reserve chairman Ben Bernanke floated the prospect of a big injection of cash (through purchases of bonds) at the Kansas City Fed’s late-summer meeting in Jackson Hole, Wyoming.

“I believe that additional purchases of longer-term securities, should the FOMC choose to undertake them, would be effective in further easing financial conditions,” he said.

That speech, on August 27th, almost exactly coincided with the market’s recent lows. Since then, stocks have soared and the US dollar has tanked.

Now, investors are expecting at least a $500-billion infusion of cash into the system, but anything less than $1 trillion could lead to some profit-taking. (The Fed already has spent $1.75 trillion.) A bigger number, however, could give stocks a temporary boost, as that’s probably not in the market now.

And if that isn’t enough, Friday, November 5th will bring the next monthly employment report, which could either confirm the Fed’s decision or, if it’s strong enough, perhaps throw some cold water on the central bank’s plans. So, perversely, good economic news could be bad for stocks.

For all of these reasons, the first week in November is shaping up as the ultimate “sell on the news” week.

And that’s especially true because of where the market is now.

At Wednesday’s close of 1178 in the S&P, we’re drawing very, very near a critical level marking long-term resistance to any further advances, says Todd Salamone, senior vice-president of research at Schaeffer’s Investment Research.

Salamone says the 80-month moving average (which tracks the monthly close of almost seven years of market data) peaked in April at 1204. That will become a key barrier to stocks moving higher. In April, though the S&P did peak at almost 1220, it failed to break above that resistance at month’s end, and a nasty correction began, driving stocks down to as low as 1010.

“Certainly we’re going to feel better about the market’s prospects if it [breaks through] 1205,” he tells me. He says his next target would be 1220 or 1240.

Salamone is actually “very bullish” for the next few months. He says sentiment isn’t wildly bullish and that other technical indicators show growing institutional interest in stocks. The advance/decline line—which divides the number of advancing issues by declining ones—“is looking pretty healthy,” he says.

Most of all, the total scorn with which retail investors view stocks is a strong contrarian signal, he observes, pointing out that there have been 22 consecutive weeks of outflows from US stock mutual funds.

“Retail investors have been out of the market in 2010 as they were in 2009,” he says. “If you’re a buyer when the public is selling, you’re in good shape.”

Still, he agrees that in the short run, investors are anticipating a big GOP victory and substantial money injections by the Fed.

I’m not a big believer in making big market-timing bets; no one can win that game over time. But I’ll be watching carefully over the next days and weeks.

With the S&P in shouting distance of 1200, I’m beginning to take some profits in funds and ETFs that have had big runs, and I’ll also sell a couple of dogs I never should have bought. (You own a couple of those, too, don’t you?) But I’ll be keeping the vast majority of what I’ve got and waiting for another opportunity to buy more.

You take what the market gives you, they say. But in this topsy-turvy world, sometimes you have to be prepared for the opposite of what you’d expect. Sell in November and go away? Why not?

Howard R. Gold is executive editor of MoneyShow.com. The views expressed here are his own.

Related Articles on MARKETS