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Stocks  | October 2, 2019

Summer is over and the kids are back in school. There is a nip in the air, and the sun hangs a little lower in the sky. That however, doesn’t just mean fall has arrived—it also means investors can come back from their cabanas and trade again. October is the end of the stock market’s summer doldrums and the start of its best quarter of the year.

The S&P 500 rises, on average, about 4.3% in the fourth quarter, according to Barron’s calculation, easily making it the best quarter of the year. Q4, in industry parlance, coincidently follows on the worst quarter of the year: the third quarter, or Q3. The average return for the third quarter is negative 0.1%.

That is no surprise to longtime investors familiar with the adage “sell in May and go away.” The old saying seemed to work again this year. Investors didn’t miss much if they took an extended vacation. From January through April, the Dow Jones Industrial Average rose 14%, excluding dividends. From May through September, the Dow rose about 1.2%. The S&P 500 rose 17.5% from January through April, and edged up just 1% between May and September.

While the average third-quarter return is unimpressive, stocks still tend to rise in all four quarters. That makes sense—after all, stocks go up over time. In fact, the market tends to go up about 66% of the time during the first, second, and third quarters. Stocks rise almost 80% of the time in the fourth quarter. Investors love the end of the year.

A strong fourth quarter would cap an already blockbuster year for stocks. This year, the S&P 500 has seen its best performance for the first three quarters since 1997, while the Dow notched its best first three quarters since 2013.

The reason for stock seasonality is a mystery. Stifel’s head of institutional equity strategy Barry Bannister believes investor psychology plays a role. Recessions are rare, so when investors get to the beginning of each year, the forward economic outlook is actually pretty good. Stock rise in the first quarter as a result, Bannister theorizes.

Perhaps that is also why stocks pause beginning in spring. Stock prices in the summer months reflect current economic data, but there is no news about the next year. During the fourth quarter, when third-quarter earnings are reported, investors start to get a look at the coming year. The information vacuum gets filled. Again—since recessions are rare and economic growth is far more likely than not—stocks can resume their rise.

Companies don’t often provide full-year guidance for the coming year in the fourth quarter. But management teams are willing to address the future in a limited way.

Walmart (ticker: WMT), for instance, spoke about trade wars, capital spending, and its e-commerce outlook when it met with investors in October 2018. Air carriers, such as Delta Air Lines (DAL), usually provide capacity projections for the coming year during Q4. Capacity growth has implications for airline profits, but also suggests assumptions about the health of U.S. consumer spending. Finally, industrial companies will also discuss the state of the global economy when reporting earnings. Honeywell (HON), one of the largest industrial companies in the world, sounded an early alarm about China's economy in 2018 during its third-quarter 2018 earnings conference call. That turned out to be a prescient observation—Chinese industrial activity hit its lowest level in three years in January 2019.

What’s on tap for the fourth quarter of 2019?

Investors, of course, have concerns. Growth is slowing, the U.S. dollar is strong—potentially hurting foreign income earned by U.S.-based companies—and the U.S. Chinese-trade war continues to weigh on investor sentiment. Longtime market strategist Ed Yardeni, however, still likes stocks. “I’m still using 3100 [as a target for the S&P 500] for year-end and 3500 for next year,” he tells Barron’s. His targets imply a gain of 4% for the rest of 2019 and a 13% gain in 2020, excluding dividends.

October on its own isn’t great for small-capitalization companies. The Russell 2000 averages a decline of 1.1% in October, according to Dow Jones Market Data, the worst monthly performance of the year. And Bannister expects “tumult” to last through October because of politics, trade tensions, and the slowing economy.

Maybe that suggests investors have a little more time to decide before increasing stock market exposure. They shouldn’t take too long, though.

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