How to Play the Coming Market Sell-Off

Matthew Carr By Matthew Carr, Emerging Trends Strategist

Market Trends

I hate Winter. I can’t stand the cold. I don’t like snow.

And to me, the Fall is almost as bad. The days get shorter and the temperatures start ticking lower.

But we’re coming up on my favorite time of year. And it’s not the start of football season. It’s not Halloween or Thanksgiving or Christmas. It’s the annual autumn sell-off.

And this year’s is starting to look like it might be a doozy.

The press usually calls it the “Autumn Panic.” Historically, the two darkest months of the year for stocks are September and October.

These are the months synonymous with black days in the market: “Black Monday,” “Black Tuesday,” “Black Thursday” and “Black Friday,” and even 1992’s “Black Wednesday.”

Of the 10 largest single-day point drops in the market, six took place in either September or October. And in seven of the last 11 years, the Dow Jones has finished lower in September and October.

But I don’t panic during this time of the year. I call this stretch the “Autumn Opportunity.”

And so should you.

Because in this catastrophe, there’s a secret to making money…

The VIX is Lying to You

The markets rose in August.

The VIX, the market fear index, is hanging around near year-to-date lows. And is down more than 60% from the peaks it hit during the tumultuous autumn stretch in 2011.

I’m not saying that the markets moving higher in August is a bad thing… But I am saying that underneath the surface, it may not be as rosy of a situation as it seems.

The average trading volume in August has been low – really low. Compared to the last five years, the trading volume in August is 30% below average. And August is already typically one of those lightly traded months to begin with.

Here’s the most troubling fact: August’s trading volume is the lowest monthly volume since the beginning of the recession in December 2007.

So, the market’s rise should raise an eyebrow. Hitting four-year highs on unusually low volume is not a particularly convincing pattern.

You want markets to rise on strength. Not on a tepid tide.

If I Sell in May, I Buy In…

Most investors have heard of the “Sell in May and Go Away” strategy. Not everyone realizes that the strategy begins in October.

As I mentioned above, the markets usually head lower in September and October. After that, we typically head into an end-of-year rally spurred on by the holiday consumer spending and earnings.

So, let’s take a look at last year as an example…

2011 Autumn Panic

Between September 1 and October 3, the Dow shed 1,000 points. The S&P was hit even harder.

But the selling pressure eventually stabilized. And from that low in October until May 1, 2012, the Dow pushed its way up from 10,655 to 13,279. A gain of 2,624 points, or basically a 25% increase.

The Rebound Charge

Just between October 3 and the end of December, the Dow gained more than 1,560 points – or a little less than 15%.

So, September through October is where you want to start setting up shop for your investments. Especially when you’re looking to invest in one of my favorite sectors…

Energy.

The biggest consuming time of the year for oil and natural gas is in the Winter months. Of course, this pushes the price of oil and natural gas higher, and energy stocks move up along with the commodity price increases.

So what you want to do is to target oil and natural gas in the months before demand begins to really ramp up, then exit as warmer weather forces the price back down.

Take a look at this… Just trading the SPDR S&P Oil & Gas Exploration & Production ETF (NYSE: XOP) from October 1 to May 1 over the last several years would have yielded:

XOP

Entry Price

Exit Price

Return

Oct 2, 2006 – May 1, 2007

$35.38

$43.33

22.47%

Oct 1, 2007 – May 1, 2008

$47.41

$58.75

23.41%

Oct 1, 2008 – May 1, 2009

$44.94

$30.94

-31.15

Oct 1, 2009 – May, 1 2010

$38.74

$44.74

15.49%

Oct 1, 2010 – May 1, 2011

$42.47

$63.91

50.48%

Oct 1, 2011 – May 1, 2012

$42.41

$56.38

32.94%

That means in five out of the last six years, you would’ve walked away with double-digit gains… The only exception being the abysmal stretch of the global financial collapse.

And the gains don’t include the dividend payments that are received each year in December and March.

By comparison, if you’d simply held XOP that entire time, your simple return would be a little more than 60%. So, again, all you’re doing is jumping into this sector during its prime months of the year, then exiting before the usual pullback.

This is the type of strategy that I like to compliment a long-term, slow-burning, but constantly churning away dividend portfolio. Taking advantage of seasonal trends – attacking the Autumn Panic as opportunity – can give a boost to your portfolio.