Let it ride or lock it in? What to do in the final months of 2021 with the S&P 500 up 22%

Published Sat, Oct 30 20219:41 AM EDT

"Lock it in or let it ride?" The market asks implicitly at times like this, with stocks quickly back to a record high after a brief 5% stumble, up nearly 22% ten months into 2021, returning 42% over the past year, drafting last week behind Tesla— now the fifth most valuable enterprise in the land — running from $900 billion to $1.1 trillion in five breathless days. As much as all this would seem to counsel taking some of what the market has given off the table, nearly every relevant precedent says it's not the moment to shrink back from risk. Typically, if the bears are going to catch the indexes in a given year, it will have happened by Halloween. The storied investor Bernard Baruch said, "Something that everyone knows isn't worth knowing," but everyone knows the final months of the year are disproportionately good for stocks and yet this fact remains worth heeding. Strong markets tend to lead to further strength more often than they disgorge their winnings. In the 15 years in history when the S & P 500 was up at least 20% through October, the final two months continued higher 12 of the 15 times, for a median return of nearly 6%. Years with similar rhythms as 2021 fit into this "winners keep winning" pattern, too. Since early this year, I've invoked 2017 and 2013 as possible rough templates for 2021: Post-election years that followed a volatile and stressed market phase and climbing with few and shallow pullbacks thanks to elegant sector rotation as corporate profits surged and animal spirits rebuilt. At the end of October, the year-to-date path of the S & P was right between those of 2017 and 2013, a bit closer to the higher-return year. In other ways, too, precedent frowns on caution this time of year, with both small-cap indexes and the Nasdaq 100 more often than not outperforming out of the year's final turn. Threats to the rally Market outcomes aren't all about history and seasonal tendencies, which like the fancy analytics used to manage baseball games these days don't guarantee a win. Recent years when the late-year tailwinds failed to blow and stocks had a deflating finish were 2018 and 2015. In both years, a touch-and-go economic recovery met with a tightening Federal Reserve and worsening financial conditions. Currently, the economy had a stutter-step in growth last quarter, with real GDP slipping to 2% , albeit mostly due to supply-chain-constrained car production. Both in 2018 and 2015, riskier corporate-debt spreads were widening out quickly. That's far from the case now, when such risk spreads remain firmly pinned near historic lows. The market last week managed a 1.3% gain even while absorbing several prominent disappointments in big-company results, from Amazon to Apple to Visa to Starbucks. Resilient, yes if also a bit unbalanced, with the average stock lagging the indexes notably. One reason the broader market was able to sidestep broader damage from the conspicuous downside surprises: They almost all came from issues investors have been intently focused on, and which might already have peaked: supply-chain frictions, semiconductor shortages and known declines in travel activity during the late-summer Covid surge. In aggregate, earnings so far have been good enough – three-quarters of companies beating estimates – but with a margin of outperformance closer to seven percentage points compared to mid-teens in prior quarters. Deutsche Bank points out that forward forecasts for fourth-quarter profits are rising, though barely so and only because of big upward revisions for energy companies. The patchiness of fundamental corporate performance at a time when overall profit growth is inevitably decelerating helps explain the harsh treatment of companies that come up short. Bespoke Investment Research calculates that shares of companies missing forecasts have declined 3.2% in reaction, on average, versus a gain of 0.9% for those beating. Will Fed end the party? As much as Wall Street's fixation has been on company reports the past two weeks, the macro landscape has grown rather interesting, even a bit suspenseful. Global bond markets have rushed to price in more policy-tightening moves sooner than previously anticipated in response to high inflation readings and signs central bankers are growing skittish. Short-term yields have ramped, the Bank of Canada last week abruptly quit buying bonds and the Bank of England has previewed a likely rate hike soon. The Federal Reserve meets next week and is expected to announce a wind-down of its own asset-purchase program while facing alarmed calls from billionaires and bond handicappers to hustle toward rate hikes to restrain inflation. More likely, Chair Jerome Powell sets the tapering timeline while refusing to endorse the market's current pricing of two rate hikes by the end of 2022. He'll prefer to maintain the distinction between tapering and tightening, preserve flexibility for next year while "planning to get lucky," so to speak, on his call that inflation will moderate as temporary factors ease. In other words, investors choosing to let it ride in stocks into year-end would not yet be fighting the Fed, nor would they be fighting the seasonal probabilities or the rising tide of share buybacks. Scares can and will happen, but major peaks tend not to strike upon the first tightening move or while credit markets are unworried. Too much risk chasing? Much of the unease some investors have with the macro setup derives from the unfamiliar, but not unwelcome, high-pressure, spring-loaded and compressed nature of this economic cycle. High nominal GDP growth, wages rising at their fastest pace in decades, continued pent-up savings, labor market acting tighter than virtually anyone expected several months ago. And, for sure, it's easy to scan the markets and come across markers of an aggressive risk chase underway. Billions of dollars were poured last week into short-term upside speculative call options on Tesla alone. Cash levels in investment accounts are scraping record lows relative to total equity market value or overall margin-loan balances. Cryptocurrency middlemen are hiring A-list actors as spokesmen as "meme coin" spinoffs of existing joke coins and even one tied to Netflix's "Squid Game" series spark viral buying stampedes. Still, nine months ago the scolds were pursing their lips at the vertical moves in GameStop (GME), ARK Innovation (ARKK), SPACs and profitless software companies. All those "froth pockets" were drained pretty well, all remain far off their price highs, and yet the bull market has carried higher. As bull markets tend to do even in the face of plenty of perfectly plausible reasons to stop.

"Lock it in or let it ride?"