Many traders ignore seasonal patterns, simply because they're based on the calendar.
But I'm here to tell you that seasonal trends are important, and there's a particular one that I want to highlight this week.
To find a seasonal trend, an analyst calculates how prices performed on a certain day in the past. For example, we know that since 1950, March has been an "up" month for the S&P 500 64% of the time. Since there's normally about a 59% chance of an "up" month, that's a slight seasonal bias to the "up" side.
However, that's not really a tradable seasonal pattern because it doesn't offer a very strong signal. An example of a strong signal would be one that tells us there is a 75% chance for a market gain in the next week, or if the probability of a gain in the next week is significantly below average.
...which is exactly what the charts are showing us right now.
For the next two weeks, seasonals are weak and that tells us to expect a pullback in the broad stock market.
There are several ways to look at seasonals. Two of the more popular techniques are shown below in the chart of the S&P 500.
The solid blue line on the chart shows the seasonal trend based on how the index has performed each day. This is based on the percentage change in the price of the index. At the bottom of the chart, each bar shows how often the index delivered a gain on any particular day. The size of the price moves is ignored. Red bars indicate the index moved higher less than 50% of the time on that particular day.
According to both techniques, seasonals are bearish into the end of the month.
Now, many traders will likely ignore these patterns because they believe there is no relationship between the stock market and the calendar. They're wrong.
One example of the relationship is the fact that companies deliver earnings reports at about the same time of the year each quarter. That's one reason why we see a seasonal pattern in individual stocks. That pattern can be less pronounced in broad indexes, but the current pattern is easily explained. Many investors are preparing for taxes and could be taking money out of the stock market to pay their upcoming bills.
Based on the chart above, there is a bearish seasonal bias for the next few weeks. But, while seasonal patterns can be useful, I don't believe they are enough to drive trading decisions. They could be considered as just one factor in the trading process.
Other Bearish Factors I'm Watching
I believe momentum is confirming a short-term bearish outlook for the market. The next chart shows the S&P 500 with my Profit Amplifier Momentum (PAM) indicator at the bottom. The 200-day moving average (MA) is also shown.
PAM did not confirm the price action and remains below the level seen at the February highs. This is a small divergence, but, coupled with seasonals, it is enough for me to continue being cautious.
Looking beyond technical indicators, a cautious outlook is reinforced by fundamentals and economic data.
By almost every standard fundamental measure, the stock market is overvalued. That's not a "sell" signal by any means, but it does suggest that the decline will be deeper than average when selling does begin. If there is a recession, the average decline in the S&P 500 is more than 35%.
Economic data is concerning, the latest example being last week's report that the core trend in industrial output remains weak. Economists with Well Fargo noted:
Industrial production rose a modest 0.1% in February. This followed a decline in January, which was entirely due to weakness in manufacturing. This core weakness remained in February, as manufacturing output fell 0.4%.
The Fed is no doubt watching the two consecutive declines in manufacturing. At the very least, this release reaffirms their patient stance on further policy tightening.
In a separate release this morning, we learned that the NY Fed's Empire Index fell to 3.7 in March, suggesting a near-term rebound in manufacturing activity remains limited.
Many analysts like to attribute weaker-than-expected economic reports to unique factors, and the government shutdown is proving to be a convenient scapegoat. Bullish analysts claim that the data collection process was affected by the shutdown and numbers just aren't reliable right now.
However, last week, Austan Goolsbee -- a professor of economics at the University of Chicago's Booth School of Business (also a former adviser to President Barack Obama) published an article in The New York Times that gave me pause.
Goolsbee noted:
...recessions are hard to recognize at the start. Looking back, for example, we know that a recession officially began in April 2001, yet scarcely anyone understood that then. In June 2001, only 7 percent of economists in the monthly Blue Chip survey believed a recession was underway. In the months before that 2001 recession began, only 16 percent of economists expected that a recession would start within the next year.
Action To Take
As I mentioned earlier, you shouldn't trade based on seasonal alone. But the weak economic data I'm seeing shouldn't be ignored either.
Bottom line, we are at a perilous point in the stock market, and I believe we will see a decline that scares many investors before the end of the month.
Investors would be wise to protect themselves in this market. My Profit Amplifier readers are doing just that, of course, but we're not holding back, either. Thanks to our proven strategy of using a conservative options technique to make outsized gains from bullish and bearish moves in stocks, we're placing carefully targeted trades on a weekly basis -- earning double-digit (and sometimes triple-digit) gains in the process. If you'd like to learn more, go here now.
