What to Expect in the Fourth Quarter of 2020

Overall the fourth quarter tends to be a bullish period

Senior Quantitative Analyst
Sep 30, 2020 at 8:00 AM
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With the fourth quarter starting this week, we are headed into the 2020 home stretch. The tables below summarize the quarterly returns for the S&P 500 Index (SPX) over the past 25 and 50 years. Historically speaking, the fourth quarter is usually the best quarter, averaging a 4.5% gain over the past 25 years, with 80% of the returns positive. This year has been anything but average, however. Below, we will break down the fourth quarter in several different ways to see if we can find another year that has something in common with our current environment.

SP Quarterly Returns 25 50

Presidential Election Years

One thing that separates this year from others is that 2020 is an election year. The table below shows fourth-quarter returns for each Presidential election cycle since 1937. The average fourth quarter return in election years is not as bullish as what we see above. The average return of 1.78%, however, is not bad for a quarter, given it translates to 7.3% on an annualized basis. Additionally, 75% of returns have been positive during election years. 

SP 4th Quarter

Below is a look at the individual fourth-quarter returns over the past ten election years. In two of the last five years, there have been big selloffs. The S&P 500 fell over 8% in 2000, which coincided with the middle of the tech bust. Then in 2008, near the end of the financial crisis, the index fell over 20% in the fourth quarter. On the other hand, if you toss these anomalies out, then the fourth quarter averages a 3.7% return during election years. Another interpretation is that fourth quarters during those decisive times are prone to bubbles popping, so caution is warranted.

SP Election Returns

Q4 & Investor Sentiment 

Despite the coronavirus crash earlier this year, the market has quickly recovered to new all-time highs, inspiring lot of optimism in the investment community. I base this on the average percentage of bulls in the third quarter, determined by the Investors Intelligence (II) sentiment survey, which analyzes published investment newsletters where editors decide whether sentiment is bullish, bearish or expecting a pullback.

The average percentage of bulls this past quarter was 57%, the third highest reading since 1963, which is the first year we have II data. Two other years that stand out in terms of optimism heading into the final quarter -- 1976 and 1971, in which the S&P 500 gained 2.1% and 3.7%, respectively. Based on our contrarian philosophy, we would expect substantial optimism to lead to an underperformance in stocks. So, it is comforting to hear those years saw decent quarterly gains. Diving deeper, the table below summarizes the S&P 500 fourth-quarter returns based on the average percentage of bulls in the II poll, though the reading from this poll does not seem to have much of an effect on stocks. All three sentiment brackets show an average fourth-quarter return between 3% and 4%, and around 75% of returns positive.

Fourth Quarter Bulls

Chart Path

This last chart shows the typical path the S&P 500 takes on average in the fourth quarter. I show all years since 1963 (since we have II data), election years and then when the II poll shows a lot of optimism heading into the final quarter. The yellow line combines those special circumstances which is like this year. It’s an election year in which investors, according to the II sentiment poll, are very bullish. Doing that gives us three years, 1972, 1976 and 2016 in which the S&P 500 gained 6.8%, 2.1% and 3.3%, respectively. The average chart path of those three years has the worst start of the quarter falling an average of 3% in the first half of October. By the end of the quarter, however, it’s the best outcome on the chart.

Overall, the fourth quarter has been bullish. This chart suggests that if you’re nervous about the possible increased chance at a crash (shown above during election years) then you may have about a month to make a decision. It seems the S&P 500 has tended to struggle through most of October before the rally. This has been especially true in the current circumstances we’re under with optimism heading into an election. That’s only three data points though so use caution.

SPX Q4 Return


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