Third Quarter Blues

After snapping a nine-quarter win streak with a 2.0% drop in the first three months of the year, the Dow appears poised to bounce back this quarter. Here’s where things get interesting: the third quarter of a midterm year has historically been one of the worst quarters of the four-year presidential cycle. So should investors be worried?

“Buckle up, as the calendar isn’t doing anyone any favors over the next few months. In fact, out of the four-year Presidential Cycle, the next quarter has been among the worst for stocks,” explained LPL Research Senior Market Strategist Ryan Detrick. As our LPL Chart of the Day shows, only the second quarter of an election year has posted worse average returns.

The Next Quarter Has Bears Growling

Source: LPL Research, FactSet 06/28/18

Before you start questioning your long-term strategy, there is good news: as the chart also shows, this quarter has actually been higher nearly two out of every three times. So what’s that mean? The average is skewed by a few big drops. A closer look reveals that large declines during the recession years of 2002 (-18%), 1990 (-15%), and 1974 (-24%) are drastically tilting the results, while 1998 saw a 12% drop in the third quarter amid the Asian Financial Crisis.

With expanding earnings, strong housing data, improving retail sales, and near-record highs in confidence, we see very little reason to expect a recession over the next 12-18 months—let alone next quarter. Could trade tensions play the Asian Financial Crisis’ role we saw in 1998? Though it can’t be ruled out, if you’re making comparisons to 1998, the Dow bounced back more than 17% in the fourth quarter that year. Also note in the chart the nine-month stretch following the historically weak upcoming quarter, which has posted an annualized return of nearly 18%. Although we wouldn’t be surprised to see equity volatility persist through summer, it may prove fruitful to stick to your long-term investment plan in the third quarter. We would be a buyer on weakness—focusing on small caps, value, U.S., and emerging markets.

Click here for more on our views on how trade will impact stocks, the economy, and fixed income.

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