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Stock Market Outlook: Lessons of the Fall

The mere mention of October is enough to frighten some investors, while others wonder, “What’s the big deal?”

It all comes down to perspective. Sure, five of the stock market’s worst 10 days happened in October — including 1987’s more-than-20% plunge — but overall, it’s a pretty average month for the market.

Instead, the history lessons to turn to this month are about infrequent events such as the U.S. midterm elections or when stocks appear mispriced. Here’s what investors will be watching in October:

About those elections

In the (unlikely) event you haven’t heard yet, U.S. voters will head to the polls Nov. 6 to elect all 435 seats in the House of Representatives and 35 seats in the Senate. Both are currently dominated by Republicans.

Investors are already betting on a split Congress, with Democrats possibly taking over the House. If Democrats were to gain control of both the House and Senate, that might rattle the market, says Craig Hodges, chief executive officer and portfolio manager at Hodges Capital Management, which oversees six mutual funds.

And here’s where knowing history could be useful. Since 1946, the S&P 500 has never declined in the 12 months following midterm elections, Hodges says, citing research he’s conducted. What’s more, the S&P 500 has seen an average fourth-quarter return of 7.9% during midterm election years, he adds.

But don’t be surprised if the stock market hits a temporary rough patch before then. “We certainly could see some volatility going into the elections,” says Matthew Etter, a certified financial planner and owner of Signet Financial Management, a registered investment advisor. That would be a departure from a relatively calm market recently; the S&P 500 hasn’t risen or fallen more than 1% for nearly 70 trading days.

» Not sure how to navigate volatility? A financial advisor can help guide you

What to do: While midterm elections could boost the market, there’s another important reason for optimism: Economic growth is solid. The U.S. economy grew 4.2% in the second quarter, according to the final estimate for this period, and that’s the fastest pace in nearly four years. For Hodges, that further supports being fully invested by November, not keeping cash on the sidelines. “Any dip I would use as a real buying opportunity,” he says.

Hunt for value

Remember back in January and February when the market fell 10% in a matter of days? The S&P 500 fully recouped those losses by August, and the Dow Jones Industrial Average finally did so in September.

What’s been good news for your portfolio has some investors feeling squeamish about investing when stock prices are high. But perspective matters, Hodges says, and some stocks look downright cheap. “There are more mispriced stocks in the market than I’ve ever seen before,” he says.

It all boils down to the two fundamental styles of investing: value (focusing on stocks that are undervalued by the market) versus growth (seeking stocks that deliver better-than-average returns). Growth stocks have largely been this year’s “high flyers,” while value stocks are lagging behind the performance of the broader indexes. The performance differential for these different styles has become “overstretched,” which creates opportunity for long-term investors, Etter says.

» What’s your investing style? Value vs. growth explained

Among the largest 1,000 U.S. stocks, the index tracking growth stocks has soared nearly 16% this year while the index tracking value stocks is up just 2%. Similarly, small-cap growth stocks have jumped more than 15% year-to-date; value stocks have risen 5.7%.

While it may be tempting to continue investing in the best performers, the market tends to oscillate between growth and value cycles that last about 18 months each, Etter says: “History has shown us that we don’t spend our entire life in a growth cycle.”

What to do: Investors looking for a tactical approach can prepare for this type of market change now by buying value stocks. Hodges sees fertile opportunities for stock-picking within small-caps, and in industries such as industrials, energy, homebuilding and transportation. Etter says exchange-traded funds offer an accessible way to attack this strategy, while reducing any company-specific risk. “ETFs are a great way to go, especially if you’re a newer investor to the market,” he says.

Stock market forecast

Much has been made of the long shadow of the 2008 financial crisis, in light of its 10-year anniversary. Various surveys have shown that investors remain spooked, including one conducted by NerdWallet that revealed 7% of respondents no longer invest in the stock market.

And my, what non-investors have missed. The S&P 500 has more than doubled in the past 10 years, even compared with its 2008 pre-crash high. That’s why the stock market remains attractive for buy-and-hold investors, with the S&P 500 delivering average returns of 10% annually (going back to the 1920s).

As for the outlook ahead, professionals on Wall Street forecast the S&P 500 will end the year slightly higher than its current level — up 1.7%, to be precise, according to the average forecast of strategists surveyed by CNBC. Still, there’s near-daily talk of an imminent market crash among other prognosticators.

Yes, you can prepare for a market crash, but when one strikes, your emotions could get the better of you. Nearly two-thirds of investors admit their emotions are “extremely or very influential” in their investment decisions, according to a recent survey from Raymond James Financial. That’s why many investors prefer to remove emotion altogether by working with a financial advisor — either of the human or robo-advisor variety.

If you’re navigating investing on your own, there are simple steps to take:

  • Don’t try to time the market (sell when you think the market’s at its peak). Virtually no one does so accurately.

  • Add money to your investments regularly. This strategy, known as dollar-cost averaging, smoothes out your purchase price over time.

  • Diversify your holdings across a variety of assets to reduce your overall risk.

  • Accept that volatility is inherent to investing, but not something to stress about for long-term investors.

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