5 Risks That Could Snuff Out the October Rally
Business + Economy

5 Risks That Could Snuff Out the October Rally

iStockphoto/The Fiscal Times

October has earned a scary reputation among investors, given the historic stock market crashes of 1929 and 1987 as well as the painful plunges experienced as recently as 1997 and 2008. But to the editors of the Stock Trader’s Almanac, which for 45 years has tracked and projected market cycles, October is known as a “bear killer” — the month that, while mediocre in terms of overall performance, has seen rallies that turned around 11 down markets since World War II.

Make that 12. After reaching their low for the year on October 3, stocks rallied strongly through the rest of the month. Despite a 2.5 percent drop on Monday, the Standard & Poor’s 500-stock index posted its third-best October ever and its best month since December 1991, gaining 10.77 percent. The Dow Jones Industrial Average moved more than 1,000 points higher during the month — its largest monthly point gain ever — with all 30 components of the index rising. The Dow finished October with a 9.54 percent boost, its best gain in nine years, to climb into positive territory (up 3.26 percent) for the year. The tech-heavy Nasdaq Composite index performed best of all, zooming 11.14 percent higher.

Now as the calendar turns to November, investors must wonder if the rally can continue through the end of the year. Or will stocks deliver some post-Halloween horrors? Recent history offers reason for optimism. Of the 20 best October markets since 1950, 17 have been followed by gains over the following three months, with an average gain of 6 percent, according to Jeffrey Hirsch, editor of the Stock Trader’s Almanac.

And recent readings on the U.S. economy, while not especially strong, have at least provided heartening indications that we’ve steered clear of a double-dip recession. “Over the course of the last month, we’ve got a lot of confirmation that the U.S. economy is not in recession and is not heading into recession,” says David Kelly, the chief market strategist for J.P. Morgan Funds. “That on its own should justify the move that we’ve seen in the markets.” And despite the October run, many analysts say stocks still have plenty of upside. “At this stage, on a pure valuation basis, stocks still look cheap and Treasuries still look expensive,” says Kelly.

At the same time, the bullish results on Wall Street belie the many dangers still lurking. “We believe S&P 500 index movement since the summer has been based primarily on investor willingness (or lack thereof) to carry risk rather than a fundamental shift in economic growth or profit outlook,” wrote Goldman Sachs Chief Investment Strategist David Kostin in a report on Monday, noting that, “uncertainty remains high in both Europe and the U.S. and investor risk aversion could easily reverse once again.” To drive his point home, Kostin added that, “Significant macro risks abound.”

With that in mind, here are three risk factors investors will be tracking in November as they also watch corporate earnings, jobs data and the Federal Reserve:

1. Europe
The market’s day-to-day gyrations in October continued to be tied to the outlook for Europe’s debt crisis. Stocks climbed sharply after European leaders agreed to a framework for preventing a Greek default. But questions remain about whether and how the rescue package will work. Investors are also wary about problems in Italy. Those concerns have driven Italy’s borrowing costs higher, making the country’s debt burden even more daunting.  

“They have not fixed this problem at all,” says J.P. Morgan’s Kelly. “They keep on saying they put the baby to bed, but it’s kind of like putting a three-year-old to bed. You can put them to bed, but it’s kind of hard to keep them there.” The combination of continued uncertainty and fiscal austerity could be driving Europe into recession, Kelly warns.

2. Contagion Fears
MF Global, a securities firm headed by former Goldman Sachs co-CEO and New Jersey Gov. Jon Corzine, filed for Chapter 11 bankruptcy on Monday, a move precipitated by a crisis of confidence regarding the company’s proprietary trading positions in European sovereign debt. “There might be some very large customers of MF Global that some clearinghouses do not want to take on their risk or do not want to take on their position,” David Greenberg, president of Greenberg Capital said on CNBC Monday evening. “If that happens and they are forced to liquidate, you could see a major move in the market.”

3. Super Committee
The congressional Super Committee tasked with hammering out at least $1.2 trillion in deficit reductions has until November 23 to vote on a plan, but Democrats and Republicans are still at an impasse over the idea of raising taxes. If they can’t come together on a plan, the U.S. could face another downgrade of its credit rating. And even if the two parties can find common ground, analysts worry that too much belt-tightening in the near term — including spending cuts, the possible expiration of some tax cuts, and the end of federal stimulus funding — could derail any economic progress that has been achieved.

4. Jobs
The U.S. economy posted modest 2.5 percent growth in the third quarter, according to an advance reading released by the Commerce Department last week. Economists and investors will be looking at the monthly unemployment report due out on Friday to see if that growth can continue or accelerate to the point that it makes a dent in the nation’s 9.1 percent unemployment rate. But some analysts worry that expectations have gotten ahead of reality and a disappointing number could hurt stocks, at least for a bit.

5. Earnings
More than three-quarters of S&P 500 companies have announced their results for the third quarter, with 60 percent topping expectations for earnings per share, according to Bank of America Merrill Lynch strategist Savita Subramanian. Overall, earnings per share are up 16 percent compared with the same period last year. The strong results so far haven’t led analysts to boost their projections for the fourth quarter. In fact, FactSet Research reported on Friday that analysts actually lowered their estimates by 3 percent from September 30 to October 28. Dozens more S&P 500 will announce results this week. What they say, both about last quarter and this quarter, could sway those projections and the market.