Third Quarter Window Dressing is Underway

| September 27, 2010

The average fund manager is focused on two things: outperforming a given sector benchmark and outperforming his or her competitors. When quarterly statements are sent out to clients, fund managers want to insure that their performance over the past three months has been good enough to keep their investors happy, so during the last couple of weeks of every quarter they have a tendency to increase their exposure to the sectors that did well and reduce their exposure to the sectors that did poorly. This process is called “window dressing” and it is in progress right now.

The S&P 500 index is up about 12% from the low at the beginning of July, so stocks should remain in demand during the next few sessions as window dressers increase their exposure to stocks in an attempt to look good on those third quarter statements. You can also see the process in work at the end of June as stocks were sold off following a 10% decline during the second quarter. The process is admittedly short-sighted and simply an attempt to look as good as possible, but it nearly always plays a role in market behavior during the last couple of weeks in every quarter, especially in a volatile environment such as this one that lacks a well-defined long-term trend.

As we noted this past weekend, the long-term topping formation in the stock market as at another important juncture with respect to long-term direction. Our computer models continue to favor an eventual breakdown sometime during the next few months, but in order for that scenario to remain in control, the rally from early July will need to terminate during the next week or two. The latest reaction from early September has been accompanied by low volume once again, so odds favor another violent correction after it ends. That next downtrend will likely develop in early October after the buying support of window dressing season has evaporated.

Category: Commentary, Market Update

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