November is a Weird Month

For a full transcript of this video, see below.

Hi, everyone. I'm Andrew Zatlin.

Welcome to Moneyball Economics. And this Thanksgiving week, I'd like to say that I'm thankful you’re here to listen to me — and hopefully make some money from my thoughts and ideas!

So, with that in mind, I'd like to share with you a secret that maybe you've heard, or maybe you haven't. It's that November is typically the biggest month — the most bullish month — of the year.

And yet, if you take a step back, October was up 7%.

Meanwhile, November, as we head into the last week, is up a piddly 2.5%.

Now “piddly” is obviously a relative assessment. But why was October so strong? Why is November not as strong? And what do we expect to happen next?

Stay tuned, because that's what I want to share with you.

First of all, what is the stock market?

Essentially it involves a bunch of buyers and a bunch of sellers. And what happens is stocks go up as long as someone is buying.

So what's going to dictate buying? Well, for one thing, value. If things are getting more valuable, that's one reason someone's going to come in with money. That's really an important point: coming in with money. So another reason why stocks go up is there's more money coming in. And that is the starting point.

Switching gears for a moment, have you ever thought about what a pension fund does? Pension funds hold $32 trillion around the world. The U.S. equity market, by comparison, is $40 trillion. The U.S. bond market is $46 trillion.

In other words, pension funds are the big swingers in this market. What happens to them happens to the stock market.

And there's an event every November that happens that I want to share with you so you're ready — if not this year, then next year.

Now, this year, I've tried to get you ready. I said in September that you want to plan for a bull run as we end the year. I'm going to give you one reason why I said that as we look at pension funds.

So pension funds have a mechanism, in which every month there are contributions. But in November, the contribution is the biggest one of all. That's when the big annual contributions are done by companies. It's a big deal.

Now remember, most companies’ fiscal year and calendar year are not the same. Most global companies end the year in October. November 1st is the start of their fiscal year.

And so that's why, speaking about pension fund mechanics, there's this massive contribution.

Well, let's talk about pension funds and what they do…

A pension fund is taking that money and investing in bonds and stocks. So it's not typically going to invest exclusively in the stock market because a pension fund is looking long-term.

They're trying to get, you know, a 5% return. And that means they're looking at relatively risk-free investing, which is — most of the time — some combination of bonds and stocks. That’s one thing to understand.

The second thing to understand is that pensions have to operate within certain parameters. They have defined rules that stipulate, for instance, how much they can hold in certain equity classes, how much they can hold in bonds, and the general portfolio that they have.

This is the same, by the way, with an Exchange Traded Fund (ETF), with a hedge fund — every company out there that's a “fund” — has to collect money and invest it in a predetermined mathematical way.

That mathematics means, for example, I can only invest in small caps or I can only invest in precious metals. That's a sector-specific parameter or one based on the size of the company.

There's also, in general, a question of how much stocks I can own relative to bonds. That's key. Because the math comes into this picture. This year, in particular, is a forced situation whereby when they come to November, and this wave of money comes in, pension funds have to do a look-back and look at their current holdings and say, “Hey, how much of my portfolio needs to be changed in order for me to stay within the regulated, agreed-upon balancing that I have?”

Well, this year's a little bit unique…

Bond prices are going down because rates are going up. So if you're a pension fund, your share of your portfolio of bonds has shrunk, simply because the price has gone down.

So normally, what a pension fund would have to do would be to buy more bonds. Why? Let's say they're supposed to have 50/50 split between stocks to bond. Only now, they're at 60/40 because the 50% of bonds has dropped in value. So bonds represent only 40% of the total portfolio.

Well, you know what they gotta do…

They gotta go out and sell stock and buy bonds. Well on top of the bond prices going down, stock prices have shot up. So they've got a double whammy — a double reason to sell stock.

Let me recap:

In November, a lot of money comes to the table, thanks to companies paying out their annual contributions. And all of a sudden, this year, it's not a buying November, it's a selling November.

And so that's why October was so huge — because everyone was positioning for November to be that typical bullish market. And indeed, 83% of companies have released earnings that were above expectations. So there was really a good reason to be bullish.

But now that we're here in November, pension funds have a problem:

The market has raced up so high and now they've got to buy stuff. And they don't want to buy. They're trying to buy bonds and sell stock. And that's why November is starting to kind of be a little soft.

December will be different, but November isn't. Companies have got to shove this money somewhere and they're being forced to sell. Hedge funds, at least the big ones, are in a similar position, but they've got a couple of other things happening.

With respect to hedge funds, a lot of the big ones are also looking at their holdings quarterly — not weekly or monthly, but quarterly. And they have to do the same exercise.

They have the same rules and regulations that dictate how their money is allocated. And so they're having to make sure they're in compliance. And again, stocks have gone up.

Now, some of hedge funds, a lot of them, in fact, are not going to be hit with this need to balance a portfolio that includes both bonds and stocks. A lot of them might contain pure stock and they're okay.

But there's another layer of selling pressure.

And that is year-end “window dressing,” or profit-management efforts.

Remember, hedge funds want that bonus. The last thing they want to do is sit here as they get graded in November. (Based on bonuses that get dealt with in December and then paid out in January, but are being determined now.)

And if you’re a trader or fund manager, the last thing you want to do is screw anything up from here. So you're going to be very cautious about the positions you're taking.

And so you more or less have taken the positions you want. You want to preserve your bonus. And, let's face it, you want to window-dress a little bit and make it look good.

So the combination of the two, the pension funds and the hedge fund, is creating a little bit of selling pressure. Because again, stock price share of the portfolio has gotten too high.

So what I'm saying is we had a massive run-up in October. We're kind of dribbling into November because, while the good news is there, there's a lot of reason to remain bullish.

It makes sense to take some profits off the table and rebalance your portfolio a little bit.

And that's what we're going to experience going into December.

But, I believe December and January, we'll continue this momentum. There's another reason why I believe this.

And that'll be in Part 2 that I'll share later this week, and it has to do with what's happening in China.

China is imploding. And when China's economy implodes, that's the nail — and they've got a hammer, and that hammer is easy money.

In the meantime, you folks have a wonderful Turkey Day.

I hope you enjoy time with your friends, your family, and all of your loved ones.

Zatlin out. Take care.

In it to win it,

Moneyball Economics