Now that October is behind us, we are into what are traditionally the best months of the year for stocks. I’m sure there is a little apprehension given the huge rally we saw in October.
From a low of 1,075, the S&P 500 rallied 210 points, closing at 1,253 yesterday. That’s a 16.5% gain in a month. And there are some pretty amazing statistics to go along with that gain.
First, the worst stocks from July-September have performed the best in October. The 50 worst stocks in the S&P 500 were up 35% since October 3rd. Conversely, the 50 best posted only a 6.9% gain.
We can look at this a couple ways. From a bearish perspective, we might conclude that the rally was largely short covering as the negative catalyst from Europe withered. Or, we might think that the worst stocks rallied as part of a leveling process based on an improved outlook.
It’s most likely a combination of the two. But I’m still not going to be quick to say that the market will reverse and take back the recent gains. The fact remains that earnings have been solid and economic data has improved.
The forward P/E for the S&P 500 is about 13, which is not expensive. And the overall strength of earnings in the third quarter, when many economists thought the economy was weakening, is a good sign that earnings momentum is largely intact.
October 2011 was the best month for stocks since October of 1974. No other month has done better since 1939. January of 1987 posted a 13% gain.
Even in those blowout months, the following month hasn’t proved to predictably bearish. In fact, of the nine months that were better than October 2011, only four followed up with a down month. And the biggest decline was 7.4%. January of 1987 followed up with a 3.7% gain.
Currently, 94% of the S&P 500 is trading above the 50-day moving average. And 100% of financial stocks are above their 50-day moving averages.
I know it’s tempting to say that stocks are overbought and due for a correction. And while it’s true that stocks may be overbought, they can stay that way for a long time. In fact, rallies can continue for some time when stocks are overbought because sometimes they are overbought for a reason — like when a negative catalyst is removed and stocks are relatively cheap.
After Thursday’s post-Euro-deal blowout rally, Friday’s action was encouraging. Stocks could have sold off and I doubt anyone would have stood in the way. Instead, prices oscillated around the flat line all day.
It’s reasonable to expect the stock market to consolidate, or even pull back a bit after the terrific October we had. Still, it’s quite likely that any dip will be short-lived and can be used as an entry point.
As a hint, keep an eye on oil prices. So long as oil prices stay strong and above $90, it likely indicates growth expectations for the global economy are intact.