Stocks are starting to look vulnerable as the ‘cruellest month of the year’ approaches
Uh-oh: September is approaching, ratcheting up the drama on a precarious stock market.
The month arrives at a time when recovering stock prices face rising interest rates, slower economic activity and muted corporate profits.
If that’s not enough to rattle investors, consider that September historically has delivered the worst average returns of any month for U.S. stocks.
According to Bespoke Investment Group, the Dow Jones Industrial Average in September has declined by 1.2 per cent, on average, and showed a positive return just 40 per cent of the time over the past 100 years – making it by far the worst month for stocks.
“In our business, September has often tended to be the cruellest month of the year,” Ed Yardeni, chief investment strategist at Yardeni Research, said in a note this week.
While he’s not spooked by the coming month’s poor track record, there are plenty of reasons why many observers believe next month could be particularly important in establishing whether the summer’s stock market recovery has legs.
For one thing, it’s a big month for central bank policy, which has been focused on fighting inflation at the expense of economic activity.
Federal Reserve chair Jerome Powell’s Friday speech at the central banker Jackson Hole conference in Wyoming, which weighed on markets all week, added to widespread concerns the Fed will continue to hike rates even if it brings pain to households and businesses.
“Those are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain,” Mr. Powell said.
The S&P 500 index fell 3.4 per cent on Friday, suggesting those comments weren’t what investors had hoped to hear when economic activity is already stumbling.
In one of the more alarming indicators, S&P Global’s flash composite purchasing managers’ index for U.S. companies – a reading of manufacturing and service sector activity – slumped to 45 in August, down from 47.7 last month.
Any reading below 50 shows a contraction. And this particular one, according to Capital Economics, is consistent with a deep recession.
Corporate profits are also starting to look vulnerable.
Most of Canada’s biggest banks reported their latest quarterly financial results this week, with some missing forecasts and bolstering provisions for loan losses in expectation of problems ahead.
Though companies in the S&P 500 reported profit growth of 8.5 per cent in the second quarter, year over year, according to Refinitiv, results from the red-hot energy sector are masking broader problems. Indeed, exclude the energy sector, and S&P 500 profits are down 2.2 per cent.
Perhaps this wouldn’t matter much if stocks were in the dumps.
But after the S&P 500 turned in its worst six-month performance since 1970 at the start of this year, the index has embarked upon an impressive – if fitful – comeback in the second half: It has risen 13.5 per cent from its low in mid-June.
Investors are showing more interest by putting money back into equity mutual funds and exchange-traded funds.
According to data from Refinitiv Lipper, investors put a net US$11.7-billion into equity funds over a two-week period earlier this month, reversing US$44.1-billion of outflows in June and July.
These enthusiastic investors likely hope U.S. inflation peaked in June at 9.1 per cent. Key commodity prices, such as crude oil, have declined since then. The Commerce Department’s personal consumption expenditures index, released Friday, showed consumer prices subsided in July.
But Mr. Powell’s comments on Friday suggest the Federal Reserve isn’t content.
“Overall, Powell tried to make clear that policy rate tightening would continue and they wouldn’t be deterred by a sustained period of below-trend growth,” Taylor Schleich and Jocelyn Paquet, economists at National Bank Financial, said in a note.
What does this mean for stocks?
They could always continue to rebound as inflationary pressures subside and the economy glides toward either a shallow recession or avoids one altogether.
But plenty of observers are cautious. Morgan Stanley’s Global Investment Committee believes the recent rebound is a bear market rally – short-term gains that occur within a broader downturn. In part, the gains point to relatively high stock valuations that might not reflect slowing profits.
“It’s not unusual for stocks to rally during a bear market,” Lisa Shalett, Morgan Stanley’s chief investment officer, wealth management, said in a note this week.
Rallies have occurred in nearly every bear market over the past 95 years, she said. The average gain during these rallies was 18 per cent, before the downward slide resumed.
September is not going to be easy.
