With summer over and fall beginning, the market may be ready to turn a new leaf—and a big, green bullish leaf at that.
Over the past five years, the fourth quarter has been an especially good time to own stocks. And with managed money badly lagging the S&P 500 for 2014 as the fourth quarter kicks off on Wednesday, the market may be in for a surge of bullish bets that could drive stocks significantly higher.
"A lot of funds have underperformed the market, and as you get into the fourth quarter, you'll definitely see a lot of performance chasing," said MacNeil Curry, technical strategist at Bank of America Merrill Lynch. "We do tend to see a strong trend where anyone who is a buyer of risk tends to do very well in Q4 as well as in Q1—in equities in particular."
In a recent note, Tom Lee of Fundstrat Global Advisors (formerly of JP Morgan) noted that just 6 percent of large-cap fund managers are beating their benchmark by 2.5 percent or more, which is "below the long-term average of 26 percent, and the worst performance since 1997."
Because of this, "even as fund managers are gloomy given the underperformance, we expect them to chase 'beta' in 4Q" and become more bullish in their positioning, which is a clear tailwind for stocks.
Lee, who is bullish for a variety of reasons, has a 2,100 year-end target on the S&P 500.
Over recent years, the market has done much better over the final quarter of the year than during the first three, perhaps due to the strong effect of performance-chasing. Brian Stutland of Equity Armor Investments points out that from 2009 to 2013, over the last three months of the year, only 20 percent of the months were negative. That's compared to 36 percent down months over the first nine months.
And from 2007 through 2013, the median compounded annualized return for the fourth quarter is 24 percent, compared to 12 percent for the first three quarters. (The mean compounded annualized returns for both time periods is 7.7 percent, but that's skewed by the horrific fourth quarter of 2008).
"I think we're headed for one last push-up, kind of that blow-off top in the equity market that we might see in October or November," Stutland said. "So I'm looking to buy dips in the market, to play for the end of the year."