10.12 Third Quarter Market Update: Volatility Rules

Turning the calendar over to the month of October in the market means 75 percent of the trading days for the year are now in the rear view mirror and there are just a few months left to close out the year.

After starting the year on a strong note, the third quarter was a rough stretch for the market. Volatility picked up after years of relatively low volatility in the market and the S&P 500 Index pulled back about 12.5 percent from the May peak to the low in August. Interestingly enough, this was the first pullback in the market of 10 percent or more in over three years. The market, on average, experiences a pullback of at least 10 percent once per year going back to 1928 in the S&P 500. So, yes, the volatility in the market has increased a bit relative to recent years, yet the correction in the S&P 500 could be seen as a normal pullback relative to historical averages.

With that said, often during a market decline, we find that important shifts are underway between asset classes, between style boxes, or between sectors. We have not really seen that happen with this current correction. Sectors that were in leadership positions coming into the correction remain leaders today. Healthcare and Consumer Cyclicals are two of the strongest sectors. The Healthcare sector has been bruised in the recent market pullback, but so far the relative strength readings are holding strong. Technology continues to do well and Financials are picking up some steam here. Still at the bottom of the relative strength rankings are the Energy and Basic Materials sectors.

U.S. Equities remains the top ranked asset class; however, International Equities have fallen from number two to number five (out of six) over the course of the year. The Commodity asset class remains the weakest of the six.

As we move through the month of the October, we are reminded that this month, historically speaking, is associated with an elevated level of volatility, but it is also the last month in the “seasonally weak” six month period in the market as it marks the end of the “sell in May and go away” market adage. Our short-term market indicators have moved into oversold territory and in some cases are as low as they have been in years.

We will watch for reversals up from these levels and use that as an opportunity to put more money to work within the equity market. Remember that November 1st is the beginning of a period in the market that is known as the “seasonally strong six month period” and rest assured that we are paying attention to the market and how portfolios are positioned.

Clayton Wertz, Investment Advisor, Echelon Investment Management