September Market Outlook: Strength Leads to Strength
While economic storm clouds continue to build, the U.S. equity market remains remarkably resilient. The price action in August was a perfect example of how the market has been able to weather negative news and continue to push higher. After ending July on shaky footing, the S&P dropped by more than -6% over the first three trading days of August, making it the largest short-term decline since June 2022. However, as has been the pattern over the past 20 months, this brief period of weakness quickly faded. Following a -3.00% decline on August 5th, the S&P rocketed higher by 8.65% over the rest of the month. This recovery is even more impressive given the fact that August is historically one of the market’s weakest months.
As we look ahead in this September market outlook, we anticipate increased volatility over the next two months, which may lead to some turbulent market days.
However, our historical analysis provides some confidence. When the S&P 500 has shown strength similar to this year's performance, the market has historically closed higher by year-end. Through August of this year, the S&P was up by 18.42%, making it the ninth-best performance for the index over the first eight months of the year.
The chart below highlights previous years when the S&P 500 was up more than 10% through August. It includes the monthly returns for the rest of the year, the total index returns over the final four months, and the full-year index return.
Key observations from this data set:
September tends to be a weak spot for the S&P 500, regardless of its prior strength. Historically, the S&P has averaged a decline of around 0.40% in September. Most recently, after gaining more than 18% through August, the index dropped nearly 5% in September 2021
The average monthly return for the market in October is heavily skewed by the crash of 1987. Removing the -21.76% in October 1987, the S&P posted an average gain of nearly 1%.
While September and October are just about evenly split between positive and negative performance, the months of November and December are almost always positive.
The cumulative performance over the last four months of the year averages a gain of 4.02%. However, excluding the 1987 crash, the average return rises to 5.57%. Only three years—1979, 1986, and 1987—saw negative returns during this period.
Regardless of market action in the final four months, when the S&P has been up more than 10% by the end of August, the index has always finished the year with a positive return.
While there might be an increase in volatility over the next 6-8 weeks, history shows that we should expect the market to be able to remain resilient in the short-term. We are still looking for a “blowoff top” scenario where stocks rise sharply before recommending a more defensive stance.
Wall of Worry: Near-Term Concerns in the September Market Outlook
Below is a quick synopsis of some of the near-term concerns that could pressure the market over the coming weeks:
The Presidential Election
This year’s election cycle adds an extra layer of uncertainty to the September market outlook. Historically, volatility increases as we approach the final stretch of an election year. President Biden dropping out of the race has led the market to adjust its expectations, creating some of the weakness we saw in late July and early August. We still expect volatility leading up to Election Day in 2024.
Japanese Yen Carry Trade
Japan has struggled with deflation for two decades, and the BoJ kept rates at or below 0.00%, encouraging investors to borrow yen for higher-yielding investments, growing the carry trade. This year, the BoJ raised rates slightly and began tapering bond purchases, which caused a spike in the yen, forcing traders to unwind positions and triggering broad selloffs. Though the BoJ eased its stance after the Nikkei 225 dropped, the massive size of the carry trade still poses a risk, and any significant yen rally could quickly increase market volatility.
The Fed
It finally appears that at their Sept 18th meeting, the Fed will finally begin to cut interest rates. Expectations are for 0.25% reduction with an outlook of at least one other rate cut in 2024, possibly two. While it’s nice that the Fed is recognizing the US economy’s weakness, they are (once again) late to cut rates, this time significantly.
We continue to believe that the economy would not experience such extreme boom and bust cycles if the Fed would allow rates to float in the direction of the 2-Year Treasury yield. When the Fed rate is above the 2-Year yield, policy is too tight and harms the economy. Yet here we are 19 months since the Fed rate moved above the 2-Year yield, the longest such period on record, and now at an almost 2% spread. Moving forward, it’s crucial that the Fed maintains a dovish stance on rate cuts and clearly communicates their outlook. The greatest risk is if they remain too conservative in reducing rates.
4. Economic Data
We covered much of the economic data we’re tracking in our latest Recession Warning video, so I won’t go into detail here. Our main concern is that the economy could deteriorate faster than expected, causing a market shock from unexpected data releases. While this is more of a 2025 concern, it’s something to monitor through the end of the year.
Feel free to watch the video presentation if you missed it:
September Market Outlook
Since the Election Year Pattern has shifted from the more bullish “Sitting President Running” pattern to an “Open Field” pattern, we expect some seasonal volatility in the next two months. However, this volatility may be less pronounced due to the unprecedented late swap of Democratic candidates. Harris is running on Biden’s platform, so there are fewer unknowns than in a typical open field race.
One strong area in the market over the past few weeks has been the daily breadth readings on the New York Stock Exchange (NYSE). Breadth measures the difference between advancing and declining issues on an exchange. More advancing shares signal a positive trend, while more declines are negative. In August, cumulative breadth on the NYSE reached an all-time high.
Finally, our Money Flow data on the S&P 500 that we use to gauge overall market liquidity, has remained very strong since last November. As we approach a potential market top, we will watch for any negative divergences between weakening money flow and rising S&P prices. For now, the indicator shows ample liquidity.
September is historically the worst month for the market, with all major indices averaging slightly negative returns over the past 50 years. Surprisingly, election-year performance is slightly better, though still negative. We expect the same for this September market outlook, based on our timing model and potential short-term liquidity drains from 3Q tax payments and T-Bill retirements. While our model predicts the timing and duration of market weakness, it doesn’t measure the magnitude. If weakness extends beyond our expectations, we will update our commentary.
Ranch Capital Advisors
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