Health Care Loses Its Immunity

Here are some notes on recent market activity.

— The S&P 500 started last week with a 2.5% plunge on Monday. From that close to the Friday close, the market rose 3.7% to finish up 1% for the week. It sure looks like the week’s action amounted to a second test of the August lows. However, before you get your hopes up, keep in mind that the charts have been faking people out all year, so this might be just one more of that series. Note that the Russell 2000 actually undercut its August low, which paradoxically could be a positive.

— Corrections typically take down every sector. Until the past two weeks, health care had been immune. Not anymore. Bespoke analysts note that not one health-care stock in the S&P 500 was above its 50-day average at the start of the week. That had only happened twice before in recent history: during the worst of the financial crisis in 2008 and near the lows of summer 2011.

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— On Tuesday, Sept. 29, the Nasdaq Biotech index sank for the eighth session in a row, finishing down 20%. That was the longest streak of losses for the index since October 2008, and only the sixth time in the index’s history that it declined for eight or more straight days, according to Bespoke data. Since 1994, there have only been four other periods where the index saw a similar 20%+ decline in eight trading days: March 2000, March 2001, September 2001 and October 2008. The average return for the index one month later was 3.1%; three months later, 17%; and six months later, 11.5%. But the analysts warn there was not a straight line higher for biotechs, as all but one featured another 7% decline in the next few months. In short, this is probably a good time to pick up some biotechs for at least a six-month hold, but be ready for further volatility.

— Biotech is naturally now in a bear market. Of the 18 prior biotech bear markets, Bespoke data shows the average length was about three months, over which time the index dropped an average of 29.3%. Based on these prior declines, if the current bear market follows the average path, it would imply further downside of about 10% over the course of the next three weeks, the analysts said.

— If a counter-trend rally emerges now, expect the most unloved groups to rise the most as late-coming short-sellers see their profits go up in flames. This would be the energy, materials and mining groups, as well as health care.

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Season to Taste

October has a bad reputation for weak seasonality but — surprise — it actually tends to feature gains. In the last 100, 50 and 20 years, according to Bespoke Investment Group data, the month has gained 0.24%, 0.65% and 1.6% respectively, with a positive result 70% of the time. All three months of the fourth quarter have tended to be strong for markets, with October, November and December all averaging 1%+ gains with positive frequency at 70%, according to the data, summarized in the chart below.

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The S&P 500 is entering October down big for two months in a row and also down for the year.

Bespoke analysts ran the numbers to see what has tended to happen in October in years when the S&P 500 has been down at least 1% in August, down at least 1% in September, and is entering October down for the year. Ten years since 1928 fit this criteria, the analysts say, and perhaps surprisingly the market hasn’t done too bad in the subsequent October. The average change for the month has been +2.15% with positive returns 60% of the time. That’s better than the average change of +0.46% for all Octobers since 1928. For the entire fourth quarter, the index has averaged a gain of 2.01% with positive returns eight out of 10 times.

Next up for markets – earnings season, which kicks off this week and could help set the tone for equities for the fourth quarter.

Best wishes,

Jon Markman