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How can equity investors handle the three weakest weeks in the year for North American equity markets?

Historically, the three weakest weeks for the S&P 500 Index and the TSX Composite Index are from the last week in September to the second week in October.

On average, both indexes dropped 2.3 per cent per period during the past 20 periods. The weakest week during the three-week period was the last week in September when the S&P 500 Index fell in 34 periods out of 50 for an average decline of 0.84 per cent per period.

Several events contribute to weakness during the period.

Weakness normally happens just after "quadruple witching," when sophisticated investors are repositioning listed options, futures and equities following expiry of September derivative contracts. Positions unexpectedly put to investors on derivative expiry frequently are sold, contributing to downside pressure just after quadruple witching.

Another reason for the decline is the start of "earnings confession" season when a company realizes that it will not meet third-quarter revenue and earnings guidance. Negative surprises on the pre-release of third quarter results have a direct impact on shares of the announcing companies.

The most prominent reason is the launching by analysts of revenue and earnings estimates for the following year. Frequently, analysts will realize that their expectations for the current year are too high based on projection for next year and they will scale back their third and fourth quarter estimates. Lower estimates contribute to selling pressures on equities.

What about this year?

Analysts already are showing concerns about third-quarter results. According to FactSet, consensus earnings estimates for S&P 500 companies on a year-over-year basis show a decline 4.4 per cent and revenues are expected to drop 2.9 per cent. To date, 75 S&P 500 companies have issued negative third quarter guidance and 33 companies have issued positive guidance.

Consensus earnings estimates for the 30 Dow Jones Industrial Average companies are less encouraging. Average (median) earnings per share estimates on a year-over-year basis project a drop of 5.8 per cent. Only 11 Dow Jones Industrial Average companies are expected to report higher earnings per share. Energy companies and companies most exposed to strength in the U.S. Dollar are prominent on the list expected to report lower earnings per share.

The outlook for S&P/TSX 60 companies is slightly more positive. Average (median) earnings per share are expected to increase 2.4 per cent. Thirty-two companies are expected to report higher earnings, two are expected to report flat earnings, 25 are expected to report lower earnings and one company does not have comparable results. Energy companies are prominent on the list for declining earnings per share.

Expected weakness in North American equity markets during the next three weeks related to pre-determined events will provide a buying opportunity. Fortunately, North American equity markets already are intermediate oversold. Technical signs suggest that North American equity markets probably reached their lows on Aug. 25 with the S&P 500 at 1,867.01 and the TSX Composite Index at 12,705.17. The stage once again is set for the traditional upside move in North American equity markets that starts in the last half of October. The seasonal charts below show history of the S&P 500 Index and TSX Composite Index for the past 20 years.

Traders and investors can take advantage by buying a wide variety of U.S. and Canadian equities and broadly based Exchange Traded Funds on weakness during the next three weeks. ETF examples include S&P 500 SPDRs (SPY-N) for U.S. funds. Choices for Canadian funds include iShares S&P/TSX 60 units (XIU-T), Horizons S&P/TSX 60 units (HXT-T) and BMO S&P/TSX Capped Composite units (ZCN-T).

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Disclaimer: Don Vialoux is author of free daily reports on equity markets, sectors, commodities and Exchange Traded Funds available at www.timingthemarket.ca. The enclosed report is for information only. It should not be considered as advice to purchase or to sell mentioned securities. Data offered in this report is believed to be accurate, but is not guaranteed.

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