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Monday, September 30, 2013 - 13:00
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Tuesday, October 22, 2013 - 14:53
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Monday, September 30, 2013 - 13:00

2 Overlooked Indicators Point To Fourth-Quarter Gains

Monday, September 30, 2013 - 1:00pm

Stocks pulled back last week and prices could fall a little more before this pullback ends. But there are two very good indicators pointing to higher stock prices by the end of the year.

Fourth Quarter Could Determine Wall Street Bonuses
SPDR S&P 500 (NYSE: SPY) dropped 1.06% last week. There are reasons to believe this is only a dip and stocks will move higher into the end of the year.

There are two bullish indicators that many investors are overlooking. Many institutions and individuals have underperformed the S&P 500 so far this year and will be trying to make up for that in the next few months.

Numerous market professionals may find they need a strong performance in the fourth quarter to lock in a bonus.

Hedge fund managers and other institutional investors get paid for performance. A typical hedge fund, for example, charges "Two and Twenty," which means managers get 2% a year in management fees and 20% of the profits above their benchmark as a performance fee. Many funds are benchmarked to the S&P 500 index, and many of those managers seem to be below their benchmark.

At the end of August, the latest available data, the Credit Suisse Hedge Fund Index shows a gain of 4.03%. SPY showed a gain of 14.91% at that time. If performance fees were calculated then, the average hedge fund manager would not receive anything. Hedge fund managers enjoy getting those performance fees, and I think they will be aggressively managing their funds to earn one by the end of the year. This should result in increased buying of momentum stocks on dips.

Individual investors might also be disappointed with their portfolio performance so far this year because, I believe, many individuals have a large share of their portfolio in cash.

Last week, I was at a meeting of professional market analysts and I had a chance to speak with the head of technical research at Fidelity. They manage about $4 trillion and have about 500 different equity funds. His team provides research to the portfolio managers of those funds. He did not offer any opinions about the stock market, but we covered a number of topics in general terms.

One of the most interesting facts I learned from our discussion is that the largest stock fund, Fidelity Contrafund, has about $98 billion in assets while the Fidelity Cash Reserves fund has about $120 billion in assets. Usually, equity funds dwarf money management funds in size.

Numbers like this show that individual investors have a great deal of cash on the sidelines. I believe that they will move that cash into stocks and the asset reallocation process will take years, which should support stock prices in the long term.

These factors might seem trivial to some, but money managers do review their performance at least quarterly and believe there is a career risk associated with underperformance. They likely will not take excessive risks, but they may buy dips more aggressively than they did earlier in the year.

As evidence to support my theory, the chart below shows that since SPY began trading in 1993, the fourth quarter has provided a gain more often than other quarters, up 80% of the time.

There will likely be short-term declines in the market, but I believe a bullish long-term outlook is appropriate here. Be prepared to buy dips when they come. Budget battles in Washington, D.C., should create buying opportunities this week.

Major Analysts Increasingly Bearish on Gold

SPDR Gold Shares (NYSE: GLD) continued its recovery and gained 0.79% last week. GLD is now more than 12% above its June lows, but there could be more downside ahead.

A few weeks ago, Goldman Sachs (NYSE: GS) analysts lowered their target on gold prices to $1,050 an ounce for 2014 and noted they wouldn't be surprised if gold prices fell below $1,000. Since then, analysts at three other major investment firms lowered their targets.

With gold trading at $1,338 an ounce on Friday, analysts are warning investors of a decline of as much as 21.5%:

In general, no one seems to like gold right now. Like analysts, individual investors have lowered their expectations for gold. Assets in GLD are down by almost 50% since their peak in August 2011.

In the futures market, the number of contracts being traded in gold has fallen to a 225-week low. As prices recovered in the past few months, speculators have become increasingly bullish while commercials, companies involved in mining and manufacturing processes dependent on gold, have turned bearish.

Sentiment is negative on gold and bearish extremes in sentiment are buy signals for some investors. Buying just because everyone else is bearish actually rarely works as an investment strategy. Until the commercials turn bullish, it is best to avoid the gold market from a trading perspective.

This article originally appeared on ProfitableTrading.com:
Market Outlook: 2 Overlooked Indicators Point to More Gains in Q4

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Michael J. Carr does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.