Here Comes The 3rd Quarter, Usually The Worst For The Market

What does the third quarter portend for the stock market? Historically, nothing good. It’s always the weakest period of the year, according to Sam Stovall, the esteemed chief strategist at CFRA Research.

Perhaps this pessimism is a function of the old saw: “Sell in May and go away.” That belief rests on the assumption that Wall Street is on vacation in the summer months, or at least, if on the job, has a case of warm-weather torpor.

For whatever reason, since World War II, the S&P 500 increased only 0.5% on average in the third quarter, versus rises of 2.0% to 3.8% for the other periods. The index’s best performance in the third quarter was 15.8% in 1970. Compare that to the average 20.4% for the other three intervals’ top showings.

Plus, during bad times, the third quarter happens to be when the biggest drops occur: The worst was a 26.1% decline in 1974. Meanwhile, the other three averaged 21.4% slides. While market routs historically are scattered over the calendar (October, in the fourth quarter, seems to be the leader for Wall Street disasters), September 2008 featured the collapse of Lehman Brothers, which touched off the financial crisis and the Great Recession.

Interestingly, and this fits in with the summer doldrums thesis, the third quarter declines really only kick in after June. In other words, high summer, after the June weddings and graduations, is when people usually go away on vaca.

What about sector performances and the second quarter? Stovall’s research discovered that, since 1990 (when S&P sector results first were calculated), five sectors were always found in the third period’s negative territory: communication services, consumer discretionary, energy, industrials and materials. The biggest gainers during those stricken third quarters were health care, real estate (since 2002) and technology.

This downbeat July-September phenomenon doesn’t affect just large-caps, the province of the S&P 500. In the third quarter, the small-cap Russell 2000 index also is the laggard, averaging 0.2% since 1979 (the benchmark was launched in 1984, but back data was done for five years before that). The other three periods showed returns ranging from 3.2% to 4.1% for small stocks.

Earnings are a huge factor in how the market does. For the just-completed second quarter, the FactSet consensus is for a fall of 43.9%, the worst outcome since the final quarter of 2008 (down 69.1%), which was the onset of the global financial crisis. The projection for the third quarter is somewhat less bad, at a drop of 25.4%—along with a 12.8% dip for the fourth.

Certainly, the second quarter’s earnings news is what typically would affect the market for July-September.  Investors already expect a rotten result from the second quarter, so that likely is priced in. What will happen if reported March-June earnings end up even lower than expected? Not much, says Jeff Klingelhofer, co-head of investments at Thornburg Investment Management. “Investors will dismiss the second quarter, no matter what the number is.”

But the epidemic is the prime market driver nowadays. Last week, word that cases were surging in Southern and Western states led to a market pullback. Still, as the second period ended, economic hope tied to business re-openings produced the best quarter (a 20% rally) since 1998, Bloomberg announced.

What will the market do if cases and fatalities spiral during the summer? Then that lovely optimism might shrivel, and stocks would plummet. Dr. Anthony Fauci, the government’s infectious disease expert, told a Senate panel on Tuesday that new cases of Covid-19 could jump to 100,000 per day from 40,000 now. Meantime, we’re in the midst of a bad recession with enormous unemployment, a condition that’s never good for stocks.

Another factor that could pressure stocks lower in the upcoming quarter is the presidential race. This White House contest promises to be the most vitriolic in a long time. When the quarter ends Sept. 30, the actual balloting will 33 days away. Plenty of time for investors, whatever their political persuasion, to feel lousy about where the nation is going.

The best we, and the market, can hope for is that the pain goes away sooner rather than later. And stays away. The third quarter, though, may not be in that sweet spot.