Rocky stock market faces potential pitfalls into year-end
September 30, 2015, 2:02 pm

Stocks face a make or break fourth quarter, and this year it`s guaranteed to be a more volatile period with lots of potential pitfalls.

Wall Street is becoming more negative on stocks though many strategists still expect a seasonal rally that will take the S&P 500 to a gain for the year. But the index is currently down more than 8 percent year to date, and the track record for digging out of a third-quarter slide is not good.

"I`m less confident in this market than I`ve been in a long time. It doesn`t mean I`m in the bear camp," said Randy Frederick, managing director, trading and derivatives at Charles Schwab. "We could be in for more of this yuck until December. I`m having a hard time imagining the catalyst that`s going to bring us out of this. Q3 earnings are not going to be strong enough." 

The S&P 500 closed 2 points higher Tuesday at 1,884, after rocking back forth in a wide range that took it between 1,899 and 1,871, just 4 points above its August low. The index enters the last day of the third quarter with a quarterly loss of 8.6 percent.

"I was thinking we could see high single-digit gains this year, but I`m now in the boat where we`ll be fortunate if we get back to unchanged," Frederick said.

The S&P 500 would have to climb 16 percent to meet the median forecast of 2,200 expected by the Wall Street strategists, surveyed by CNBC. 

The last two times stocks surged that much in a quarter was back in the second quarter of 1997 and fourth quarter of 1998, the volatile years of the Asian financial crisis and the Long-Term Capital Management hedge fund collapse, respectively. 

"Between the spring of 2009 and the end of the year, the S&P was up 40 percent. But we were starting way down in value and now we were just a few points from the all-time high," said Frederick. "I was hoping we`d get a Fed rate hike and that would give us a nice boost that would be a shot in the arm of confidence for the economy."

Some strategists have been paring back their expectations and now see smaller stock market gains, but Goldman Sachs strategists Tuesday said they see an actual decline. The last time stocks were negative for the year was 2011 when the S&P was less than one-tenth of a point lower than 2010`s last close. The decline before that was the 38 percent drop in 2008.

The Goldman analysts ratcheted back their year-end forecast from 2,100 to 2,000 for the S&P 500. The index started the year at 2,058. The analysts also trimmed earnings estimates by 4 percent and their 2016 GDP forecast to 2.4 percent. 

They cited a combination of slower economic activity in China and the U.S. and the drop in oil prices, which has slammed energy earnings. 

The market faces a number of formidable challenges this quarter, including two Fed meetings. Central officials have re-emphasized that they hope to raise rates this year after passing on a hike in September. While the market puts higher odds of a first-quarter rate increase, analysts expect volatility around the Oct. 28 and Dec. 16 meetings.

"I think the Fed has painted themselves into a box," said Jeffrey Saut, Raymond James chief investment strategist. "My model has always said the Fed raises in November even though there`s not a meeting." Saut said the market would benefit from a rate hike.

The data the Fed watches will also remain key to markets, including Friday`s jobs report. ADP`s August payrolls are expected at 8:15 a.m. ET Wednesday, and economists project 194,000 jobs but ADP has not really been a good predictor of the government payrolls. September`s nonfarm payrolls are expected to increase to 203,000 from 173,000, and unemployment is expected to remain at 5.1 percent. 

There is also Chicago PMI data at 9:45 a.m. but the markets will be most focused on four Fed speakers. New York Fed President William Dudley speaks at 8:30 a.m. on liquidity. Then, Fed Chair Janet Yellen makes opening remarks at 3 p.m. at a St. Louis Fed community banking conference, and she is followed by St. Louis Fed President James Bullard. Fed Gov. Lael Brainard also speaks on community banks in St. Louis at 8:15 p.m.

While analysts do not expect Yellen to say anything about policy Wednesday, she and the other speakers will be watched closely. Both Yellen and Dudley reinforced in the last several days that central bank officials would like to raise rates this year following the Fed meeting.

Markets have also been monitoring Washington where Congress was expected to pass a spending bill Wednesday to prevent the government from being shut down. But that vote would only cover an extension that would bring it up for another vote in December, around the time the U.S. will be getting close to its debt ceiling and will need a congressional extension.

Some analysts have said a battle around the debt ceiling could delay Fed rate hikes, but Saut does not expect the issue to be a problem for markets.

"I actually think that`s not going to be a problem. The people I talk to in DC are so afraid the Republicans will get the bad rap for shutting down the government," he said.

When the Fed held off hiking rates in September, it pointed to international and financial developments that could impact U.S. growth. Since then, markets have been more nervous about a weaker China and falling commodities prices. 

Saut said he`s cautious on stocks. "The thing that worries me most is the Dow Theory sell signal on Aug. 25. That was when the Dow and the transports closed below the mid-October closing lows. Lots of big red warning flags for me," he said.

Saut said the sell signal could be forewarning a big selloff. "It`s too soon to tell until we find if we`re making a double bottom," he said. Saut said he`s waiting out the current period of volatility. "I`m not doing anything. I`m exercising the rarest commodity on Wall Street — patience. There`s this human need to be in it when sometimes the best strategy is to be inactive," he said.

If history is a guide, odds are against the market staging a major fourth-quarter rally. According to Bespoke, since 1930, in the years when the S&P 500 was lower on the year after three quarters, it has averaged a decline of 0.65 percent in the fourth quarter. It does gain 53.3 percent of the time. 

But when the S&P is up year to date through the third quarter, it has almost always been higher in the fourth quarter. In years when the S&P is higher year to date through September, the average fourth quarter return has been 4.33 percent, and the index has been positive 82.5 percent of the time, or 47 of 57 occurrences.

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