Well we are almost through the month of September and overall the market has come through with flying colors, despite the fact that September has historically been the worst performing month for the stock market.

Of course, as I wrote about on 8/29 http://www.optionetics.com/market/articles/2012/08/29/kaeppels-corner-fear-and-loathing-in-the-month-of-september, September tends to be a tale of two trends.  Trading days #1-14 tends to perform OK while Trading days #15-21, well, not so much (See Figure 1). 

Figure 1 – Growth of $1,000 invested in Dow during September Trading Days #1-14 (blue line) and September Trading Days 15-21 (red line) since 1955

This pattern has held true (with one day left) so far this year, with the S&P 500 advancing +3.8% from 8/31 through 9/21 (Trading Day #14), and then trending lower since (See Figure 2).

Figure 2 – S&P 500 up through Trading Day #14, down since

Likewise, as I also wrote about http://www.optionetics.com/market/articles/2012/09/19/kaeppels-corner-time-for-energy-to-run-out-of-well-energy, energy stocks have been week so far during the seasonally unfavorable period of September Trading Day #10 through October Trading Day #6 (See Figure 3).  

Figure 3 – OIH: Trending Lower after September Trading Day #10

So what lies in store for the month of October?  As always, I have to go with my pat answer of “it beats the heck out of me.”  Sadly, my ability to “predict” the future isn’t what I would like (is anyone’s really?).  Still, happily my ability to “look back” has proven fairly useful over the years.  So let’s take a look down Memory Lane and highlight some potential candidates for the month of October.

Two Bullish Candidates

If I could only pick to funds to buy and hold during the month of October (and of course in reality, no such limitation exists, still it makes for a great segue, no?) they would be:

-Fidelity Select Software (ticker FSCSX)

-Fidelity Select Electronics (ticker FSELX)

For those who use ETFs instead, the alternatives would be:

-Vanguard Information Technology (ticker VGT)

-HLDRs Semiconductor (ticker SMH)

Why these two you might ask?  Figure 4 displays the gain or loss generated by a portfolio made up of the two Fidelity funds during the month of October since 1991.

Figure 4 – FSCSX/FSELX Portfolio during October versus S&P 500

Some relevant numbers regarding a 2-fund portfolio made up of FSCSX and FSELX during the month of October since 1991:

-Up 15 times

-Down 6 times

-Biggest up = +25.5% (2001)

-Biggest down = -15.9% (2008)

-Average gain = +4.6% (S&P 500 average gain = +1.6%)

-Median gain = +5.1% (S&P 500 average gain = +1.8%)

-Outperformed S&P 500 = 15 times

-Underperformed S&P 500 = 6 times

-$1,000 invested in two funds only during October = $2,390 (+139%)

-$1,000 invested in S&P 500 only during October = $1,354 (+35.4%)

Figure 5 displays the year-to-year growth of $1,000 invested in October in our 2-fund portfolio (blue line) versus the S&P 500 (red line)

Figure 5 – FSCSX/FSELX 2-fund portfolio (blue line) versus S&P 500 (red line) during month of October since 1991

So will this simple 2 fund portfolio make money and outperform the S&P 500 during October 2012?  Please refer back to my “pat answer”.

One Bearish Play

Gold stocks have a terrible track record during most of the month of October.  Specifically, gold stocks tend to perform very poorly between the close of September Trading Day #21 (or the last trading day of the month if there are less than 21 trading days) and October Trading Day #19. 

Figure 6 displays the growth – or rather the destruction of $1,000 invested in FSAGX only during our unfavorable seasonal period 1989.  It isn’t pretty.

Figure 6 – Decline of $1,000 invested in FSAGX from end of September through October Trading Day #19 (since 1988)

As with any other seasonal trend, it is far from 100% accurate.  All told, FSAGX has declined 16 times during this period over the past 23 year, or 70% of the time.

Still, all told, an original $1,000 starting in 1989 has declined to $254, for a net loss of almost -75%.  There is no reason that gold tocks cannot rally between now and 10/25 (October Trading Day #19), but these results should at least give one a little bit of pause.

One Technical Note

The most aggressive play would be to play the short side of gold stocks.  FSAGX cannot be sold short.  Aggressive investors can consider the following:

-Buying put options on ticker GDX or ticker GDXJ

-Buying ticker DUST, which trades inversely to gold stocks using leverage of 3 to 1 (in other words, if gold stocks go down 1% on a day, this ETF should go up roughly 3%). Please be aware that this is an extremely volatile play and that this fund can make some huge moves.  So if you decide to play the short side of gold stocks, don’t bet the ranch.

Summary

Predicting the future is “tough”, to put it mildly.  Relying on the past – as we do when we rely on seasonal trends – is certainly no “sure thing” either.  As we have seen with the stock market managing a decent rally during the “dreaded” month of September, past trends are never guaranteed to repeat.

Still, it is important in any game of chance to put the odds on your side as best you can and to take steps to minimize your risk on any position.  Holding a long position in software and electronics stocks and a short position in gold stocks during the month of October has historically been a profitable play.

How will things work out this time around?  Well, like I said, “don’t bet the ranch.” 

Jay Kaeppel

Staff Writer and Trading Strategist

Optionetics.com ~ Your Options Education Site