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U.S. President Barack Obama speaks to military personnel at Fort Bliss in El Paso, Texas August 31, 2012. (Gary Cameron/Reuters)

U.S. President Barack Obama speaks to military personnel at Fort Bliss in El Paso, Texas August 31, 2012.

(Gary Cameron/Reuters)

ETFs

ETFs to see you through the U.S. election Add to ...

History shows that September is the cruelest month of the year for equity markets. History appears poised to repeat.

September has been the weakest month of the year for North American equity markets during the past 60 periods. During the past 10 Septembers, the S&P 500 Index dropped an average of 0.95 per cent per period, the Dow Jones Industrial Average fell 1.44 per cent, the NASDAQ Composite Index lost 1.25 per cent and the TSX Composite gave up 1.40 per cent. The worst performing sector was the semiconductor sector with an average drop of 9.30 per cent per period.

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Weakness in equity markets in September is universal: The Nikkei Average dropped an average of 0.97 per cent per period during the past 10 periods, the London FT Index gave up 0.98 per cent, the Frankfurt DAX lost 1.54 per cent and the Paris CAC fell 3.32 per cent.

A series of annual recurring events tend to influence equity markets negatively in September. First, institutional investors have a history of adjusting their equity portfolios after returning from holidays. In particular, many U.S. investment funds are looking for ways to improve tax efficiencies in their portfolios. They do so by liquidating underperforming securities prior to their fiscal year end in October.

Second, analysts tend to reduce earnings estimates for the current year prior to release of third-quarter results. Analysts have a history of over-estimating annual results in the first half of the year following positive guidance offered in annual reports and annual meetings. After release of second-quarter results in July and August, they realize their projections are unlikely to be achieved by year end and they respond accordingly. This year analysts are responding to negative guidance released by many companies when second-quarter results were released.

Several unique events are expected to influence equity markets this year. First, technical indicators show that equity markets are intermediate overbought and vulnerable to at least a short-term correction. The S&P 500 Index gained 12.6 per cent from June 4 to August 21 and recently began to roll over. The S&P 500 Index recorded a rare bearish key reversal on August 21 that normally leads to stock market weakness during at least the next six weeks.

Second, this year is a U.S. Presidential election year when U.S. equity markets have a history of moving lower from mid-August until mid-October. Weakness is most notable when Presidential election polls show a tight race. The latest polls released over the weekend show a dead heat between President Obama and Mitt Romney. Weakness is related to uncertainty about who will be the next president and which policies will be implemented under the next administration.

Third, growth in the U.S. economy already is slowing due to approach of the “Fiscal Cliff” at the end of the year. The “Fiscal Cliff” implies an increase in income, dividend and capital gains tax rates, an increase in payroll tax rates, a decline in unemployment benefits and a drop in defense spending. Chances that President Obama and Congress will reach an agreement prior to the election to forestall the Fiscal Cliff are virtually zero.

And now the good news! Equity markets in developed nations historically have moved higher after investors determine who the next president will be. Equity indices frequently reach annual highs between late October and the end of the year. Investors with a time horizon of less than two months will want to protect the value of their portfolios during the current period of uncertainty. Several methods are available including the purchase of listed put options on major equity indices and the purchase of inverse equity index Exchange Traded Funds against part of the value of your portfolio.

Investors can choose between 17 inverse ETFs in the U.S. Most actively traded inverse ETFs are Short S&P 500 Proshares, Short Russell 2000 Proshares, Short Dow 30 Proshares and Short QQQ Proshares. In Canada, Horizons offers BetaPro S&P/TSX 60 ETF and BetaPro S&P 500 ETF. Both trade in Canadian Dollars. The BetaPro S&P 500 ETF is hedged against currency risk.

The preferred strategy for investors with a time horizon longer of than two months is to continue to hold positions with favourable seasonal and fundamental prospects fully realizing that value of their portfolio is likely to decline before the end of October.

Don Vialoux is the author of free daily reports on equity markets, sectors, commodities and Exchange Traded Funds. He is also a research analyst at Horizons Investment Management, offering research on Horizons Seasonal Rotation ETF (HAC-T). All of the views expressed herein are his personal views although they may be reflected in positions or transactions in the various client portfolios managed by Horizons Investment. Horizons Investment is the investment manager for the Horizons family of ETFs. Daily reports are available at http://www.timingthemarket.ca/

Follow on Twitter: @EquityClock

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