For those of you who would prefer to listen:
September sure started out with a bang. Not in a good way. The low volume rally into Labor Day proved to be a bit of a sucker’s rally as the winds changed towards Autumn. The increased volatility sure has shaken investors out this Summer. Buy-the-dip has worked all year. The 8% August sell-off in the wake of the Japan crash nearly got erased last week as the S&P came within 1% of its all-time highs reached in July. The Dow actually hit new highs. Then September hit.
Risk takers have largely been rewarded for the past year. It’s been a risk-on environment with Tech stocks leading the charge in the theme of AI. Any weakness has been immediately buyable. The thing about the buy-the-dip strategy: It works until it doesn’t.
Risk-off has been the big story this week. September seasonality set in. Softer economic data is driving the “bad news is bad news” sentiment. The euphoric AI trade lost its momentum. Nvidia recorded the largest one-day market cap drop in history for an American company. It lost nearly $300 Billion. It’s still up well over 100% on the year. What’s more, the Japanese Yen has strengthened again, putting more pressure on systematic global security positions. Money has sought safety so far in September.
All eyes were on the August Job Report. It’s the big data point before the Fed meeting, later this month. The central bank made it clear it no longer considered inflation the biggest economic threat. Feeling success on that, the Fed Chair pivoted focus towards the recent slowdown in jobs. In order to stick the soft-landing, the central bank wants to stabilize labor. It’s even worse than they thought.
142K jobs were created in August. That was 20K fewer than estimated. What’s more, June and July numbers were revised lower by 86K. Unemployment slipped back to 4.2%, as expected. Yields immediately fell on the news. The 10-Year Treasury fell below the technically significant 3.7% level. That’s a 14-month low. The 30-Year yield fell below 4% for the first time this year. The probability of a 1/2-point rate cut jumped to 39%. They meet in 2 weeks.
Bonds have rallied. The 2-Year Treasury yield has moved the most, commensurate with the expectations of the Fed. Short rates have collapsed. That has the yield curve steepening. The closely followed spread between 2’s and 10’s is back into positive territory. It’s no longer inverted. That ends the 25 consecutive months of inversion, the longest in history. This is where economic history gets tricky and a little dangerous. An inverted yield curve is widely seen as a recession indicator. And normalization of the curve is not necessarily a positive sign as the curve can un-invert before a recession hits. Historically, this has been positive for the Healthcare, Consumer Staples, Utilities and Transportation sectors over the next several months/quarters. That’s clearly been the leadership sectors the last few weeks.
The economic slowdown is global. Iron ore prices sunk to its lowest since 2022 on fears that China’s Economy is actually weakening further. China’s Stock Market is down 12% on the year and believe it or not, is red over 5 years. China is not strong. You also see it reflected in the price of Copper and Oil. WTI Crude went below $70 a barrel for first time this year. Brent Oil, which the majority of global crude is priced, reached its lowest level since June of 2023. The Oil Market is oversupplied, led by record American production, while demand continues to slide. Those supply dynamics sparked the continued sell-off, including a recent report indicating OPEC+ would proceed with their scheduled 180K daily barrel increase in October. They reconsidered and pushed it out for now with hopes to stabilize the price.
The good news at home is gas prices have come down. The price at the pump is the lowest since Christmas in 2021. That supports the slowing inflation but it’s a double-edged sword. America’s Economy could recess ahead. The Crude sell-off and weakening gasoline futures are among factors in this week’s ramp up of September ½-point rate cut odds, while weaker commodity prices lessen the risk of an inflation snapback after the Fed begins cutting. The one commodity that hasn’t fallen in price: Gold. The precious metal is near all-time highs. It sure is working for safety.
All of this sets up a tense go for investors. Remember, it’s September. Pretty much everyone knows by now it’s the worst month of the year for stocks. September is the only month that has been lower in each of the past 4 years. In 2022, for example, the S&P 500 experienced its worst September since 1974, declining by over 9%. It’s been a tough month for over a century. Stocks on average have declined in the month of September going back all the way to 1897.
The September Swoon is considered an anomaly, in the sense that it occurs without any real causal link or event. But the fact that it has demonstrated such a consistent pattern runs counter to that theory. Is it an anomaly if it is widely identified and publicly known? A consistent anomaly sure seems like a complete contradiction of terms. As we know, correlation is not causation. It’s just one of life’s mysteries, I suppose. It sure is real.
I did some more digging, just to try to understand why September has been such a standout negative for the Stock Market for so long. There are a number of factors and theories that seem to have contributed over the decades.
Wall Street has been notorious for taking the Summer off. Traders and fund managers would disconnect, spending time at the beach, famously in the Hamptons. That of course has changed in the Digital Age, where we are seemingly connected 24/7. But trading volume definitely slows. Conviction gets pushed out. Then Summer ends. The mad dash back after Labor Day has investors focused on year-end. Many mutual funds have fiscal year ends in the Fall. That can trigger sales of losing stocks for “window-dressing” purposes. Portfolios get rebalanced, increasing the selling volume and putting pressure on stock prices. Some try to lock in gains as well as tax losses before the end of the year.
The Bond Market also plays a role in the September Effect. September is typically a period when bond issuances spike, as many companies and governments issue new debt ahead of the fiscal year-end. As new bonds flood the Market, they attract investors who might be looking for more stable returns. That’s especially true in periods of rising interest rates, which we’ve certainly seen since 2022. That can trigger stock selling with money flowing into bonds. The Market comfortably absorbed Tuesday’s $43 Billion high-grade bond issuance. Bonds have definitely been a safe haven of late.
Tuition time: With this hypothesis, many investors have to sell a substantial amount of their stock holdings to pay for their kid’s tuition, room & board bills for college. School seems to start earlier these days, but for most, the school year begins in early September.
There’s also this impact from generations before: A century and more ago, in the era when agriculture was the primary economic activity, farmers borrowed money from banks to plant crops in the Spring and often had to sell assets to cover higher costs in the Summer before they get paid after harvest in the Fall. A good crop was great for Wall Street to close out with a year-end rally.
Back to the Fed: America’s Central Bank meets in mid-September. Its first interest rate cut since Covid is pretty much guaranteed. Typically, rate cuts are viewed as a positive event for the Stock Market, as lower rates reduce borrowing costs for companies and consumers. But we can’t lose sight of why they’re cutting. It’s because the Economy is slowing. If the Economy slows faster than anticipated, deeper rate cuts could come. That’s not exactly good news. Concerns have risen about the broader health of the Global Economy. That’s also given a lift to volatility.
There’s also the great uncertainty around the election. There’s reason to believe the outcome won’t be immediately known after November 5th. That adds a layer of risk to what is normally the start of a seasonally strong period.
We believe there is more to go in this correction. Excesses still need to be unwound. But not all is lost. While Tech corrects, Utilities, Consumer Staples and Health Care continue to catch a bid. In fact, many in this arena hit fresh, all-time highs this week. Despite the sell-off in the major indices, certain areas are still working. There’s so much going on below the surface.
Rotation is healthy. The broadening out of participation is a good thing. But the Market is showing defensive characteristics. And Tech had become such a dominant size in the Stock Market. The rest of the sectors will have trouble holding the S&P up while Tech corrects.
Believe it or not, this price action is quite normal. Over the past 6 Presidential cycles, the S&P 500 has averaged a -4.3% return during the 2-month leadup to election day. Tech has traditionally been the biggest underperformer, while defensive sectors like Consumer Staples, Utilities and Health Care have fared the best. That’s precisely what’s happening. What’s encouraging is the post-election trading has seen strong overall returns and cyclical outperformance. Q4 is always the seasonally strongest. November and December have averaged 4.2% gains in this century. Getting there is the challenge. That has many investors thinking like those boys from Rodeo, California who formed a band that launched in Berkeley. They’re Green Day and they wrote: “Wake me up when September ends… “
Hang on tight. We’ve got this.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
