Here’s some advice for investors hoping for some calm after the recent stock market volatility: “Expect the unexpected, and get yourself used to bigger swings,” says Julian Emanuel, executive director of U.S. equity and derivatives strategy at UBS. “Even though the market has a positive bias and we’re looking for a fourth-quarter rally, it’s going to remain volatile.”
Over the past 20 years, October has been the choppiest month for stocks. This year may follow the pattern of 2011, 1998, and 1990, when steep declines in August were followed by further downdrafts in October. “We are in an important seasonal stretch, a time in history when the August and October period is very volatile,” says Chris Verrone, head of technical analysis at Strategas Research Partners. “We’re not done with the correction quite yet. The repair process takes many months, and part of that repair process is going back and undercutting initial lows.”
In 2011, Europe’s sovereign debt crisis dragged down the Standard & Poor’s 500-stock index 7.2 percent in the first week of August. By mid-October the index had gone through six rallies and five pullbacks, falling as much as 6.7 percent in one day. In a six-week rout that began in August 1998, the S&P 500 experienced four rallies and four declines as it coped with the collapse of Long-Term Capital Management and slowing economies in Asia, Russia, and parts of Latin America. A similar pattern occurred in the autumn slump of 1990. In each case, stocks resumed their upward climb a month or so later, after dropping under the low reached in August.
This time around, the summer volatility began in response to China’s devaluation of the yuan and uncertainty about when the Federal Reserve would start to raise interest rates. In August the S&P 500 plunged 10 percent in four days, the first drop of that size since 2011. Since then there have been daily rallies of as much as 4 percent and declines as deep as 3.5 percent. Yet after a five-day decline that ended on Sept. 28, the gauge reversed and began its longest rally of the year, gaining 5.6 percent in the five days through Oct. 5.
Amid the turmoil, 12 of the 21 strategists surveyed by Bloomberg have lowered their yearend estimates for the stock market. Their average guess now is that the S&P 500 will finish the year at 2,142. That would be a gain of 4 percent for the year and 8.2 percent from the Oct. 6 close, which is not that much bigger than the average 6.7 percent rally that has occurred in the fourth quarter since 2009.
Even an upward path isn’t likely to be smooth. Some major indexes have already broken through their August floors. The Russell 2000 Index of smaller companies reached a new low for the year after a biotechnology stock selloff in September. Some industries in the S&P 500, such as health care and materials, also dropped past their August lows in late September.
The next thing likely to roil the market is corporate earnings, starting with Alcoa on Oct. 8. Overall, third-quarter profits are estimated to contract 6.9 percent, the largest quarterly drop since 2009, based on analysts’ estimates. Alan Gayle, senior strategist for RidgeWorth Investments in Atlanta, will be scouring the reports to see what companies are saying about their outlook for 2016. He says consumer and auto companies are doing well, “and housing activity is picking up. All of that suggests that the U.S. economy is on fairly solid ground.”
Another key influence on the market will be China, which is making renewed efforts to boost its slowing economy. “I’m looking for Chinese economic data to show that the stimulus they put into place is actually working,” says Michael Purves, chief global strategist at Weeden. “If we get the right data out of China, we’re going to get the right data out of the U.S.”
With so many unknowns, the market is likely to jump around as investors respond to each new clue on the direction of the economy, Purves says. “Even with good economic data, it’s going to be choppy,” he adds. His yearend forecast for the S&P 500 had been the highest among 21 firms tracked by Bloomberg, before he lowered his outlook by 13 percent on Oct. 5. He now expects what he calls a “wolf market,” with sharp swings but no clear direction. “It’s not like bull over. It’s bull timeout,” he says.
The best way for investors to survive the wolf is to stay calm. “We think it’s vital that investors don’t get caught up in the day-to-day flux of the market,” UBS’s Emanuel says. “What is required in higher volatility is higher discipline and better emotional control.”
The bottom line: After falling 10 percent in four days in August, the S&P 500 may dip lower before resuming a choppy climb.