Here’s what the fourth quarter means for markets

By Brian Tycangco

We're quickly heading into the fourth quarter of the year.

And that could be good news for global markets…

How markets perform in the fourth quarter

The table below shows the 10-year average performance of global indices - like the S&P 500 Index and MSCI World Index - during different quarters of the year.

As shown in the table below, shares tend to perform poorly during the third (and, to a lesser degree, second) quarters of the year - with average gains of 1.0 percent and 1.9 percent, respectively. This is where the old stock market adage, "sell in May and go away" comes from. Historically, markets tend to do poorly from May through October.

The fourth quarter has seen the highest gains in the S&P 500 Index, which has gained 3.9 percent on average during the quarter. Meanwhile, the MSCI World Index gained an average of 2.5 percent in the fourth quarter.

Asia and emerging markets also tend to perform better in the fourth quarter than in the third quarter. However, based on past data, they do best during the first two quarters of the year.

So why do stocks perform better during the fourth quarter?

First is positive sentiment. The fourth quarter often sees a stronger business environment, particularly for trade and retail because of holiday shopping. This generates more economic activity, which translates into better sentiment towards stock markets - and higher share prices.

Second is window dressing in stocks. The end of the year is when fund managers and other professional portfolio managers tend to sell the losers in their portfolio…. And buy the shares of stocks that have performed well. This is largely to create the impression (in year-end statements of portfolio holdings) that their fund has been holding winners… although may have gotten in only recently. The net impact, though, is sometimes to further boost the share prices of the best-performing shares in the year to date - and (further) depress those of underperforming shares.

Third is an increase in investable funds. The end of the year is when people usually have more disposable income to invest, thanks to year-end bonuses, gifts and salary raises. That allows more money to flow into the stock market through retirement savings accounts and personal investment accounts.

Finally, there's the anticipation of good results. When investors are generally positive on the economy and the prospect of growth in earnings of listed companies, they invest ahead of what they view will be strong year-end corporate results.

This year has been unusual

Thanks to strong economic growth in the U.S. and its advantage in the ongoing trade war with China, the S&P 500 has far outperformed its historical quarterly gains so far this year. In the third quarter alone, the index has gained 7.8 percent, and we still have a week left in September.

But crises in emerging markets like Turkey and Argentina, as well as fears that China's economy is on the losing end of the trade war, have seen those markets perform poorly in the first three quarters of the year.

The MSCI Emerging Markets Index, for example, has lost 8.2 percent since the start of the year, while the MSCI Asia ex-Japan Index has shed 6.4 percent.

Asia, in particular, has been dragged down in the third quarter by the effects of "Ghost Month", which has kept much of the Chinese investing community on the sidelines.

So what does that mean for this year's fourth quarter?

The U.S. market is currently trading at a cyclically-adjusted price-to-earnings (CAPE) ratio of 32.1 times. That's higher than the market's valuation before the Black Tuesday market crash in 1929, and twice as high as the valuation on Black Monday in 1987.

So by CAPE, the U.S. is very expensive.

Meanwhile, emerging markets and some Asian markets are among the cheapest in the world today.

Most of these markets are now trading for half the CAPE ratio of the U.S.

When you take mean reversion into account, the extreme underperformance of Asia and emerging markets in the first nine months of 2018 could point towards a reversal heading to the final months of the year… while U.S. markets - which have massively outperformed - could be in for a slowdown, especially given their lofty valuations.

 

Brian Tycangco
Brian Tycangco is an Editor and Investment Analyst with Stansberry Churchouse Research, an independent investment research company based in Singapore and Hong Kong that delivers investment insight on Asia and around the world. He's been working in the financial world since 1995 and has carved out a reputation as "Master Stock Picker". He's seen just about everything there is to see in these markets, met with the leading CEOs of every industry in Asia, and knows the ins and outs of doing business and making money there. Brian has been a stock broker at a large Asian trading house, an equities analyst for a major European investment bank, as well as editor and chief investment strategist for one of the longest-running Asian investment newsletters in the world. Click here to sign up to receive the Asia Wealth Investment Daily in your inbox every day, for free.

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