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Wednesday, November 5, 2014

Why we should buy shares in November

History tells us stocks now are entering what normally is their strongest period for gains. But some investors worry that this year, current events could outweigh history.

Over the past 100 years, the best three-month stretch for stocks has been November through January. On average, the Dow Jones Industrial Average records strong gains in all three months, jumping 1.5% in December alone, according to Bespoke Investment Group.

The S&P 500 shows a similar trend since 1928, the period for which data on that index are available. It has risen an average 3.4% over the three months, nearly double its 1.86% average gain for three-month periods in general.

Many money managers hope to see that now, even though stocks aren’t cheap.

“The fact that stocks in the U.S. are a bit stretched, which they are, doesn’t prevent them from moving ahead in the next three to six months,” said Russ Koesterich, chief investment strategist at BlackRock Inc., which manages $4.32 trillion.

Stocks have risen despite high prices all year. They rebounded from sharp pullbacks in January, April, July, September and October. The Dow is up 4.9% for 2014 and the S&P 500 has risen 9.2%, with both at record highs.

Investors offer several reasons for the November-to-January strength. Year-end is when many companies record their biggest sales, as consumers spend on the holidays and businesses invest in equipment for the new year. And January is when some retirement funds put fresh money into accounts.

But the higher stocks go, the more skittish investors become. The S&P 500 has almost tripled since its 2009 low and trades at 18.7 times component companies’ net profits for the past 12 months. That is well above its long-term average price/earnings ratio of 15.5, Birinyi Associates calculates.

With investors sitting on big gains, they are quick to take profits when they face anxiety about slow global growth, tensions with Russia or expectations the Federal Reserve will raise interest rates next year. So far, they have overcome their worries, most recently because of positive earnings reports, better U.S. and European economic numbers and a huge new Japanese stimulus program.

The risk is that investors could sell again if they get more bad news about earnings, the economy or global tensions.

“There are so many things that could shock markets that I think are very fully valued,” said Michael Farr, president of Farr, Miller & Washington, which oversees $1.1 billion in Washington. “I would caution investors to make sure they have a seat when the music stops.”

Mr. Farr has focused on conservative stocks that tend not to fall as heavily in downdrafts, avoiding stocks such as Facebook Inc. and Twitter Inc., he said.

There are reasons for worry: The pullbacks’ frequency has increased, and the October one was particularly sharp. And other types of investments are signaling that the world economy remains troubled.

Investors are holding large sums in the relative safety of U.S. Treasury bonds, which has kept bond prices high and yields low. The appetite for Treasurys reflects doubts about the global economic and political outlook.

With the Fed ending its long-running bond-buying program and preparing to raise target interest rates, many bond experts thought Treasury yields had to rise. But after starting the year at 3%, the yield of the benchmark 10-year Treasury note finished Friday at 2.335%.

Oil shows a similar pattern. Crude-oil futures finished Friday at $80.54 a barrel, down 18.2% for 2014 and off 11.6% in October alone. Soft oil demand is widely seen as a sign that China’s economy is slowing, crimping its need for raw materials. Industrial metals have behaved similarly.

Corporate earnings also could be better. With two-thirds of big companies reporting, their profits are up 7.3% for the third quarter. That is above the 4.5% analysts projected at September’s end, but below the 8.9% they expected in June, said John Butters, senior earnings analyst at FactSet. The results look good mainly because analysts cut their forecasts, notably in the weak energy and financial sectors.

“Overall, the numbers have come down and the companies have turned around and beat those estimates,” Mr. Butters said.

Analysts now are cutting estimates for future sales and earnings, at a time when investors believe companies need to boost sales to keep record profit margins up. Analysts now forecast 2.6% fourth-quarter sales gains, down from 3.8% forecast at the end of September.

And yet, money managers see reasons for optimism.

In addition to stocks’ normally strong performance from November through January, stocks also do well following off-year congressional elections and at the end of lame-duck presidential terms. That is true even when stocks have risen a lot in the previous year or two. Stocks also often advance when Washington is gridlocked, said Bespoke Investment Group’s co-founder, Paul Hickey.

And slow earnings and economic gains aren’t necessarily bad, especially if they hold down interest rates, inflation and wage gains. Capital costs and wages are two of the biggest expenses companies face, and keeping them low boosts profits.

“This slow, grinding growth, with very low interest rates and not much in the way of wage gains” is why profits are so high, said Mr. Koesterich of BlackRock. “Margins are a lot higher than people thought they would be, and they are staying there.”

“We could lose some steam as the Fed starts to raise rates” next year, he added, especially since Congress isn’t likely to spend on economic stimulus. But even then, he said, rates should remain so low that they shouldn’t derail the market.

The Wall Street Journal



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