Wake Me Up In November?”

The middle of July brought an announcement from the SEC that the rules regarding naked short selling in 17 financial institutions were stiffened. That created a bottom for those stocks and the market in general. We felt that the bottom was intermediate in nature and could last through the election. The action the last couple of weeks has changed my mind.

The internal makeup (volume, breadth, etc.) of the month long rally was tepid at best. We are beginning to see signs that we may reverse down again soon? We are also sensing it could be a somewhat wicked pull back? After all we are heading into what historically has tended to be the most volatile period of the year.

According to the “Stock Trader’s Almanac” September has been the worst month of the year for the S&P 500 and the Dow Jones Industrials going back to 1950. The total return has been a -35% and -55% for the S&P and the Dow respectively. Compare that to November which has a 100% return for the S&P and a 96% return for the Dow. We believe this historical pattern may play out again this year.

The month sandwiched between these extremes is the scary month of October. The Halloween month has brought the two Crashes that our stock market has experienced, 1929 and 1987. That alone is probably enough to strike fear, or at least intense caution, in many investors. If you look closer October is probably more consistently best known for making market bottoms. As far as the ranking for the total return since 1950, the month is in the middle of the pack with a +52% return for the S&P and a +33% gain for the Dow.

We have an image in our minds of what may unfold in the next several weeks. It comes from the patterns we see in the charts of many sectors/indices and the feeling of dread we sense with the Fed, SEC, and other policymakers. As we mentioned the charts appear to us to be teetering on a precipice at this time, with the likely outcome of sliding off sometime in September. We do believe the correction will pick up steam when more bad news (banking/financial related?) unfolds.

It is usually the Fed who rushes to the rescue in these types of situations, releasing the fire hose of liquidity and/or lower interest rates to calm the markets. Frankly their usual remedies have been neutered by the recent rise in the inflation numbers. The hero this time around we believe will be the SEC. We think they will come in and institute the constraints on naked short selling they did in July for the entire market. We imagine they will also bring back the uptick rule, shorting is allowed only after a stock ticks up, to further hamstring short sellers and reduce downside volatility.

If this does occur, it should not only remove some of the selling pressure, but could create a rally of significant proportions. According to SeekingAlpha.com total short interest is currently at or near all time highs. If these rules we mentioned are instituted by the SEC, it could cause the holders of these short positions to cover (buy orders). Combine a constraint on selling and a reason for shorts to cover and you could have a 10-20% rally. We know that sounds great, but with the near term correction we see occurring it could just get us back to where we are today?

Lots of conjecture with what we just shared, and again this is my image of the world and not that of Presidential Brokerage. What we would emphasize is that with the collective vulnerability we see in the charts and the history of September and early October, it is not a bad idea to put the vigilant hat back on. In fact we think that hat should be with in arms reach for the next several years.

PS If the major indices/sectors exceed their early August highs, forget everything we just said.