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Preparing for a year-long stock market rally


North American equity markets have struggled this year. Prospects of a double-dip recession, European debt issues, and general uncertainties battered equity markets until September. Broadly based equity indices are only marginally higher on the year. What can investors expect next? A rally of course!

Political action in the U.S. prior to mid-term elections is expected to set the stage for an entry point in equity markets early in the fourth quarter. Equity markets customarily reach a low in the month of October in a mid-term election year. Tendencies influencing equity markets just prior to a mid-term election include a ramp up of political rhetoric, uncertainty over a possible shift of legislative power and negative responses to economic indicators. Much of the same is anticipated this year. Additional issues are likely to influence equity market sentiment this October including uncertainties about extension of the Bush tax cuts beyond 2010, questions about another quantitative easing program proposed by the Federal Reserve and anxiety about the enactment of health care and financial reform bills. The U.S. business community is reluctant to resume spending and hiring until uncertainties are alleviated.

The lows of October during mid-term election years customarily present a buying opportunity for equity investors. As the overhang surrounding November elections is alleviated, investors enter the market in droves. Since 1950, returns in a mid-term election year from October lows to the end of December have been double that of the gains achieved in an average year. The year-end rally in a mid-term election year has recorded gains averaging 8 percent on the S&P 500 Index and 6 percent for the Dow Jones Industrial Average. U.S. equity indices continue to rally well into the following year, known as the pre-election year. U.S. equity indices have a history of reaching their high during a pre-election year in October. The 12-month rally from the October mid-term election low to the October pre-election year high averaged a gain of 24 percent by the S&P 500 Index and 19 percent by the Dow Jones Industrial Average. Positive returns were recorded by the S&P 500 Index in 15 of the last 15 periods. Returns ranged from 5.87 percent in 1978/1979 to 40.12 percent in 1986/1987, with 11 of 15 periods showing gains topping 20 percent.

October is important when determining if an equity market bottom is in place. Key housing and employment indicators are showing signs of a recovery. On the other hand, third quarter earning reports announced in October could be a problem. Analysts have started to respond to slowing U.S. economic growth in the third quarter by reducing earnings estimates.

When should investors enter equity markets for the next period of seasonal strength? Lows in October customarily are reached in mid to late October following release of third quarter earnings reports. Technical indicators, such as Moving Average Convergence Divergence and key volume spikes, will provide a clue when fine tuning an entry point.

Sectors expected to outperform include Technology, Materials, Consumer Discretionary and Industrials. Much of the expected strength in these sectors is related to an economic recovery that will see GDP growth return to pre-recession levels.



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