For those still longing, Friday brought some fresh news. Sharp declines in the S&P 500 and Nasdaq 100 indices. A meme-stock dumping ground. Data from Wall Street trading shops showing that hedge funds are once again getting hot with their shorts – and those shorts are making money. A tracking basket of bearish speculator favorites slid more than 6%, bringing its weekly decline to the maximum since the March 2020 crash.
The pressure to find out soon is high after a $7 trillion rally erupted amid the Federal Reserve’s steepest rate hike campaign in a generation. The feeding arguments for letting equity bets rise are strong earnings and chart patterns suggesting the gains could last, including the S&P 500 erasing half of its losses in the bear market, a feat with an unlikely hit record . What is less encouraging is that September is the toughest month for equities, the Fed may want the rally to stop and no one can tell if a recession will be averted.
The choice is also somewhat of a referendum on how seriously to take the current high pain threshold for investors. While history shows that Northern Hemisphere falls are when many rallies die, history has never seen retail day traders capable of generating rallies on nearly insolvent stocks or push the S&P 500 up 9% in a month when the Fed tightens. Old realities collide with new tactics. Something will probably have to give.
“I expect September to be volatile,” said Peter Tchir, head of macro strategy at Academy Securities. “The good news is that trading desks will be fully staffed and we may see more liquidity in the markets, but the bad news is that any mispricing could be ‘corrected’ quickly.”
Not only is September the month with the worst average performance for the S&P 500, it’s also the only month where stocks fall more frequently than they rise, according to Sam Stovall, chief investment strategist at CFRA. The index fell an average of 1% during the month, according to data compiled by Yardeni Research. Only two others – February and May – tend to see negative returns and neither is as turbulent as September.
Still, inflation hasn’t been this high in decades, which makes the current cycle different, said Alex Chaloff, co-head of investment strategies at Bernstein Private Wealth Management.
“I don’t think we can say, ‘Well, the fall is always hard.’ It’s less relevant today,” he said. “If we get a continuation in a weaker inflation reading, if we have a decent jobs report when it comes to net new additions and have some wage growth – but not enough people think that will boost inflation – that’s the perfect recipe for a falling rally.”
Meanwhile, seasonality maxims have not held up this year, according to Kristina Hooper, chief global market strategist at Invesco. The performance since May has not been as disastrous as the adage “Sell in May and leave” might have predicted.
“I’m not sure this year fits historical patterns,” she said in an interview at Bloomberg headquarters in New York. “Now I don’t expect big things this fall, but I think the current stock market rally should be sustained and we could see the end of the year a bit higher than today.”
Up nearly 12% since the end of June, the S&P 500 is off to the best start to a third quarter since 1932. And although it fell 1.2% this week – its first week of decline in five – it is up 2.4% for the month so far.
Tchir says a big driver of volatility will be next month’s Fed meeting. Consumer price reports as well as employment data for August ahead could help shape market expectations ahead of this decision. Policymakers also travel to Jackson Hole, Wyoming, at the end of the month for an annual policy retreat.
Investors ignored increasingly thorny warnings from Fed officials, who stressed they were far from done raising rates. San Francisco Fed President Mary Daly said this week that the central bank should raise interest rates “a little” above 3% by the end of the year, pushing back bets investors that officials would then reverse course.
“I would expect the Fed to play a big role if we get a swoon in September,” said Mike Bailey, director of research at FBB Capital Partners. “Earnings are on the sidelines until mid-October, so inflation and Fed action will be the focus until then.”
Bearish traders, crushed in the July-August rally, are showing signs of life again. And hedge funds, which have borrowed stocks to bet on further declines, this week stopped hedging or started reloading on shorts, according to data from prime brokers JPMorgan Chase & Co. and Goldman Sachs Group Inc. show.
September is also when many portfolio managers return from summer getaways. “They’re coming back from vacation and want to reposition themselves,” Zhiwei Ren, portfolio manager at Penn Mutual Asset Management, said in an interview. “And the repositioning of portfolios will lead to significant buying and selling flows.”