October Could Be a Long Tough Month for Stocks

It was the best of times… The best September for the broad indexes since 1939. Alas, “the September rally looks tired,” opines Dan Amoss, editor of Strategic Short Report, as we kick off this first full week of October.

“The timing and size of the Federal Reserve’s next round of money printing,” suggests Dan, “are driving the stock market right now. My read of both factors tells me that the market is at risk of another sharp move lower.

Stock and Bond Yield

“The S&P 500 is encountering strong ‘resistance’ at 1,150. One can easily imagine a return back to 1,050 – the starting point of the latest sprint.

“Plus, one of the key indicators of a sustainable rally is missing: Treasury yields haven’t budged much at all (see blue line above). Contrast the barely noticeable blip up in yields with the spring 2009 leap of 150 basis points in a few months.”

Then notice how the benchmark 10-Year Treasury yield sits about where it did when the S&P hit bottom in March 2009.

“The Fed is promising to buy more Treasuries,” Mr. Amoss explains, helping to put this week’s trading into context for us. “Primary dealers have run out of other attractive trades and are front-running the Fed.

“Personally, I think these traders jumped the gun. With gold breaking out to new highs and the stock market in a happy mood, I doubt the Fed will be aggressive anytime soon. Rather, I expect the Fed to spend its limited political capital when financial market indicators are much more stressed.

“In other words, because the markets have already anticipated quantitative easing (QE2) by pushing up stocks and Treasury bond prices, it’s less likely to happen soon.”

In this light, it’s worth pointing out the “retail investor” sat out the “best September since 1939.” Money has fled stock mutual funds ever since the late-April highs, to the tune of $43 billion in the third quarter.

Money Leaves Stock Mutual Funds

Trading volumes are thin. Hedge funds are guarding against potential losses and banks are taking free money from the Fed to play high-frequency trading games, but that’s it.

Quality stocks?

“Investors aren’t responding to quality in any shape or form,” says Morningstar’s director of equity research Pat Dorsey. “In fact, forget about quality – they’re just not responding to stocks.”

Here’s another figure weighing on institutional minds…if not individuals.

On Friday, as the new fiscal year dawned, the Treasury was still crunching the numbers for the final day of the old fiscal year…it appeared Uncle Sam ran up the national debt $1,545,753,247,046.20.

This morning…looks like they were off by some $100 billion. The official total rang it at $1,641,083,866,542.37.

Meh… What’s a hundred billion among friends?

“The tax base just isn’t recovering anywhere near where it was near the peak in GDP,” Dan points out. Despite campaign rhetoric about reigning in federal spending, neither party is committed to making it happen – regardless of turnout or outcome in the first week of November.

So what’s it all mean for stocks in October?

“With year-over-year earnings comparisons getting tougher,” Dan concludes, plus “federal stimulus spending fading, 99-week unemployment benefits beginning to roll off for the chronically unemployed that were laid off in fall 2008 after Lehman’s bankruptcy, this should be an interesting earnings season…”

Translation: a long, tough month for stocks ahead.

Addison Wiggin
for The Daily Reckoning

The Daily Reckoning