10-15-24: We’re Seeing Some Seasonality in Reverse

by Ivan Martchev

October 15, 2024

Another week and another all-time high in the S&P 500 and Dow Industrials make investors wonder what has happened to the negative seasonality that is supposed to plague the markets at this time of the year.

This year, the negative seasonality has been completely missing. The most obvious catalyst for any sell-off would be the coming Israeli retaliation for the Iranian missile attack and how it might affect the price of oil. If it turns out to be more than just a one-off event, and they begin to trade missile strikes, it is hard to see the markets continuing to rally, as it will likely affect the price of oil. We don’t know when such a retaliation might come, but leaks to the press suggest it might be before the U.S. election.

Then, the most important question is: Would it tip the balance in favor of one political party or the other?

The fact remains that the U.S. stock market is acting well and is likely to see further gains after the election, no matter who wins, as it will become clear what the policies of any new administration would be. It is entirely possible that we may be looking at another 5%-10% rally in November and December if there is no full-blown war between Israel and Iran, which at this juncture is impossible to predict.

Can Hong Kong (and Some Chinese) Stocks Continue Their Recent Rally?

One market that is not done rallying is Hong Kong, plus some select stocks in mainland China. The Shanghai Composite has been a complete disaster for over 17 years, as many of the state-owned enterprises (SOEs) listed there are not run for profit, so GDP growth does not translate into profit growth.

With China, we have the bizarre situation where a rapidly growing economy (for several decades) does not result in the appreciation of its stock market. The Shanghai Composite closed on Friday at 3218. The first time it reached that level was in 2007 and it has been back and forth, below and above it, ever since.

It is possible for the Shanghai market to become more like a normal stock market, but for that to happen, we need to see many reforms in mainland China that have not happened yet, and it is unknowable when they will happen. The Hong Kong Hang Seng Index companies, by comparison, are run for profit, but that index is prone to violent rallies and equally violent sell-offs, even though it tends to appreciate a little better than the mainland market over time. If the Chinese enact the necessary reforms that go beyond giving companies and investors money to buy stocks, the index can appreciate quite a bit more from here.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The first big spike in the Hang Seng Index came when Henry Kissinger made his secret trip to China in 1971 in order to prepare for the visit of President Richard Nixon in 1972. At the time of Kissinger’s visit, the Hang Seng Index was trading near 280. When investors got excited about China opening up in 1973, the Hang Seng Index made it to 1750. By January 1975 when reality set in and they realized that it would take a while for China reforms to get going, the index was below the level it saw in 1971 (chart, below).

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Ever since, there have been many violent rallies and sell-offs in the Hang Seng Index, although it has appreciated over time. The Chinese – and the Japanese, for that matter – are momentum traders. I do not believe that the latest surge in the Hang Seng index is the end of the rally; it probably has further to go, particularly if the Chinese introduce a series of market-friendly reforms to get the economy moving.

Under that scenario, it would not be surprising if the Hang Seng makes an all-time high in 2025.

In order to have a vibrant stock market in China, the central government needs to move away from the model of state-sponsored capitalism. There are no indications now that they are ready to loosen their grip on the economy, although they would like to see both the economy and the stock market improve in 2025.