Sector Seasonality Review and Buying Dips Ahead of “Best Months”

For 46 years the new edition of the Stock Trader’s Almanac has been released early in the fourth quarter. And for the past twelve years we have been preparing Almanac Investor readers for the annual October ETF buying spree. This year is no exception, but before delving into October’s seasonalities, let’s do a quick review for new and veteran readers alike.

Every year while preparing the annual Almanac, we revisit and analyze our sector seasonalities (STA 2014 pages 92 to 96) in order to make adjustments for any new or developing trends. For the most part, seasonality has been on track since September 2009. As a result there have only been a few minor revisions made to our Sector Seasonalities table over the past few years. The mere fact that there were just a few changes validates these seasonal patterns. If they did not repeat on a regular and recurring basis then they would not be seasonalities. Years of sector research allows us to specify whether the seasonality starts or finishes in the beginning third (B), middle third (M) or last third (E) of the month based upon the number of trading days in the month.

These entry and exit points will be the basis for our seasonal trades over the coming year. They are guidelines, as we generally look to enter new positions before the start of the favorable period and exit before its end. Occasionally a trade is closed out well in advance of the seasonality’s end. An outsized advance may trigger a trade at the recommended auto-sell price (a price target based upon past historical performance of the specific seasonality) or should strength fail to materialize, a stop loss could be reached.

There are eleven sector seasonalities that enter their favorable periods in October. The following trade ideas are made based upon these seasonalities. Currently, all buy limits are just below current market levels. The market had struggled in August as QE tapering concerns and Mideast tensions escalated, but these concerns are easing. In fact, NASDAQ has already broken out to new recovery highs improving the probabilities that DJIA, S&P 500 and Russell 2000 will soon follow suit.

New Recommendations for October Seasonalities

Transports enter their historically favorable season at the beginning of October and it runs until May. iShares DJ Transports (IYT) is attractive below current levels with a buy limit of $115.67. The stop loss is $104.10 and auto sell is $154.72. Top 5 holdings are: Union Pacific, Kansas City Southern, FedEx, UPS, and Alaska Air Group. A pickup in Chinese growth and exports usually translates directly to a pick up in the transportation sector. After all, those goods need to be moved from the factory to stores. With nearly 70% of U.S GDP coming from consumers, seasonal strength in the consumer sector overlaps nicely with the transportation sector.

Broker/Dealer has produced returns of 32.7% and 18.2% over the last 15 and 5 years respectively from early October to the middle of April. iShares DJ US Broker-Dealers (IAI) is our choice to trade this seasonality. Use a buy limit of $32.61 and a stop loss of $29.35 once a position has been entered. The auto sell is $47.60. Top 5 holdings are: Goldman Sachs, Morgan Stanley, Charles Schwab, Ameriprise Financial and CME Group. Solid year-to-date market gains and the end of the summer doldrums are likely to boost profits for this group. However, trading screw ups, software glitches and litigation costs are still major concerns.

Healthcare Providers enters its favorable season at the end of October and runs until mid-January. iShares DJ US Healthcare Providers (IHF) is attractive near current levels with a buy limit of $87.53. The stop loss is $78.78 and auto sell is $109.09. Top 5 holdings are: UnitedHealth, Express Scripts, Wellpoint, Aetna, and Cigna. Healthcare costs are an issue in the U.S., but much like food and shelter they are a necessity in life making it much easier for this group to pass its costs on to the consumer. Double-digit annual premium increases have been the norm lately. This trend is not likely to change even as Obamacare’s insurance exchanges are launched.

Pharmaceutical is also in favor from mid-October, until the start of the New Year. iShares DJ US Pharmaceutical (IHE) is the top selection. Enter this trade with a buy limit of $106.47 and employ a stop loss of $95.82. Take profits at the auto sell of $125.43. Top 5 holdings are: J&J, Pfizer, Merck, Bristol-Myers Squibb, and Eli Lilly. Presumably, the more people with health insurance the greater the demand for pharmaceuticals will be. Whether the newly insured is paying for the insurance or not, they are likely going to see the doctor more frequently.

Over the last 15 years, Telecom has generated an average return of 10.4%, but for the last 5 years the average has slipped to 5.1% during its bullish seasonality from the middle of October through yearend. The top ETF within this sector is iShares DJ US Telecom (IYZ). Use a buy limit of $27.21 and stop loss of $24.49. If above average gains materialize, take profits at the auto sell of $33.04. Top 5 holdings are: AT&T, Verizon, Crown Castle, CenturyLink and SBA Communications. Aggressive competition in the sector has not been kind to growth, but IYZ does boast a 2.76% yield and Apple is releasing two new phones just in time for the holiday shopping season.

Over the last 15 years, Cyclical has generated an average return of 21.9%, and for the last five years the average is 21.6% during its bullish season from October to May. Our top ETF within this sector is SPDR Industrial (XLI). A buy limit of $45.42 and stop loss of $40.88 are appropriate. If XLI produces above average gains, profits will be taken at the auto sell of $60.90. Top 5 holdings are: GE, United Technologies, Union Pacific, Boeing and 3M. Global growth is the key to this sector’s success or failure. Recent data suggests that it is improving, albeit modestly.

The Banking sector has a favorable period that runs from the beginning of October and lasts through the beginning of May with a historical return of 15.1% over the last 15 years and 18.2% over the last five. Buy SPDR S&P Bank (KBE) with a buy limit of $30.29. Once purchased, use a stop loss of $27.26 and an auto sell of $38.35. Top 5 holdings are: CapitalSource, Prosperity Bancshares, Ocwen Financial, Synovus Financial and MGIC Investment Corp. Regional banks account for nearly 70% of KBE’s assets. Unlike their much larger and well-known brethren, there is still room for growth at the regional level.

Materials have a favorable period that runs from the middle of October through the middle of May with historical returns of 17.0% over the last 15 years and 10.4% over the last five. Buy SPDR Materials (XLB) with a buy limit of $41.69. Once purchased, set a stop loss of $37.52 and an auto sell of $53.66. Top 5 holdings are: Monsanto, Du Pont, Dow Chemical, Praxair and Freeport-McMoran. Although many commodities have lost their luster and remain off their relatively recent all-time highs, growth normally requires raw materials. As growth expectations for 2014 and beyond improve, this sector is likely to see a boost as well.

Semiconductors come into favor near October’s end and remain so until the beginning of December. This trade has averaged 16.6% and 8.1% gains over the last 15- and 5-year periods, respectively. SPDR Semiconductors (XSD) is the top selection. Establish new positions with a buy limit of $56.79 and utilize a stop loss of $51.11. Take profits at the auto sell of $72.84. Top 5 holdings are: Cirrus Logic, SunPower, Micron Technology, Cavium and Xilinx. Portable electronic devices, like Smartphones and tablets, and the networks that they use are the drivers of growth for this sector. Traditional PC chip makers are still represented in XSD, but not as heavily. Holiday spending and fresh innovative products are needed to keep this sector rolling.

Computer Tech comes into favor in early October and remains so until the beginning of January. This trade has averaged 18.2% and 8.6% gains over the last 15- and 5-year periods, respectively. SPDR Technology (XLK) is the top selection. Enter this trade with a buy limit of $32.15 and employ a stop loss of $28.94. Take profits at the auto sell of $41.80. Top 5 holdings are: Apple, Google, Microsoft, IBM and AT&T. Apple is the largest current holding, at 15.37% of total assets. Smartphones and tablets are quickly replacing desktops and laptops. Nearly all of XLK’s holdings are well positioned to profit from this trend either directly or indirectly.

Real Estate has seen returns of 14.2% and 18.7% over the last 15 and 5 years respectively from the end of October to the beginning of May. Vanguard REIT (VNQ) is our choice. Use a buy limit of $66.15 and a stop loss of $59.54 once a position has been entered. The auto sell is $83.10. Top 5 holdings are: Simon Property, Public Storage, HCP, Ventas, and Equity Residential. The brisk rise in Treasury-bond yields this year did take the wind out of real estate, but rates have begun to stabilize which is positive for the sector.

By Christopher Mistal