August was unusually quiet in the US markets and economy, which could be the set-up for a volatile few months ahead.
Labor Day marks the unofficial end of summer for the US. Kids return to school after their summer vacations, and the US Senate and House of Representatives head back to Washington after their lengthy summer recess. On Wall Street, traders and rainmakers close their summer homes in the Hamptons and head back to work.
“The end of summer marks a quickening in the pace of life and a longing for just a few more minutes on the deck or in the back garden,” Morgan Stanley’s Andrew Sheets wrote on Sunday. “The recent calm, with the S&P 500 moving less than 1% for 39 straight days, only makes that feeling stronger. After the relentless sell-off that rang in 2016, and the early summer shock of Brexit, the respite has been welcome. And yet it comes with a nagging suspicion. Markets like this rarely last. They will be interrupted by something.
“What will it be?”
A long list of catalysts for market volatility
US Jobs: Things kicked off on Friday with the August US jobs report. The report was actually disappointing relative to market expectations, which caused most economists and Fed-watchers to push back their expectations for an interest rate hike from the Federal Reserve. Indeed, the futures market assigns a very low 22% probability that the Fed hikes rates at its Sept. 20-21 Federal Open Market Committee (FOMC) meeting.
Fed’s FOMC meetings: Despite the low implied probability of the Fed acting on Sept. 21, Goldman Sachs and Barclays economists are straying from the herd and telling clients that the Fed will indeed hike rates at that September meeting. Such a surprise move could spark volatility in the markets. Should the Fed wait, then it will likely raise rates in December. Whenever the next hike occurs, it would be the first hike since December of 2015.
European Central Bank meeting: The ECB meets this week and announces an update to monetary policy on Thursday. In addition to the persistent economic woes plaguing countries like Greece, Spain and Portugal, the UK’s unexpected Brexit vote has introduced another major source of economic uncertainty to the region. Economists expect no change in policy rates, which already includes a negative 0.4% deposit facility rate. If anything, the ECB could announce an extension of its asset purchase program (similar to the Fed’s quantitative easing program).
Bank of England meeting: The BoE’s Monetary Policy Committee (MPC) meets on September 15. Like the ECB, the BoE is wrestling with the uncertainty brought on by the Brexit vote. Interestingly, the impact has been surprisingly benign. “With recent activity releases suggesting the economy may have continued to expand last quarter…and fiscal adjustment due later this year, the central bank should remain in a watchful mode,” JPMorgan’s Bruce Kasman said. “However, the forward-looking elements of the business surveys hint that the adjustment to Brexit will build. If realized, the MPC will likely ease before year-end.”
Bank of Japan meeting: The BoJ announces an update to monetary policy on Sept. 21, hours before the Fed’s announcement. Like its G-4 central bank peers above, the BoJ is scrambling to get growth and inflation up. At the Kansas City Fed’s Economic Policy Symposium in Jackson Hole, BoJ governor Haruhiko Kuroda said “the Bank will continue to carefully examine risks to economic activity and
prices at each monetary policy meeting and take additional easing measures without
hesitation.” Economists believe this was a pretty blunt signal that the BoJ expects to cut rates further and increase its program of buying Japanese government bonds.
US presidential election: Campaign season kicks into high gear after the Labor Day, building up to presidential debates scheduled for Sept. 26, Oct. 9, and Oct. 19 (The vice presidential debate will be held on Oct. 4). Polls show that Democratic nominee Hillary Clinton has the lead over Republican nominee Donald Trump. But anything can happen between now and Election Day, Nov. 8.
Markets have a terrible track record in September
For what it’s worth, the historical data show that September is not a great month of stocks.
“‘Closing up the beach house’ and ‘Back to school’ tends to be associated with equity market weakness,” UBS’s Julian Emanuel said on Thursday.
For what it’s worth, the September drag has gotten less bad in more recent periods. From LPL Financial: “Going back to 1950, the average return has been a loss of 0.52% with a positive return for the month only 44% of the time. Going back to 1928, the return drops to -1.06% on average and again positive 44% of the time. But the past 10 years September has been near the middle of the pack, up 0.3% on average and higher six times.”
“Seven of the worst 26 months [since 1926] ever happened in September,” Ritholtz Wealth Management’s Michael Batnick observed. “If money was only invested in this month, $100 in 1926 would turn into $42 today.”
Batnick continued: “So yeah, it’s true, September has by far been the worst month historically. But are you really going to act on this? Come on. I mean really, come on.”
But some equity strategists would argue that it’s different this time. They point to two troubling signs:
1) The VIX (^VIX) is low. The VIX represents the premium options traders pay to protect themselves from volatility and downside. And that premium is below average, a sign of complacency in the face of all of those catalysts listed above.
“With the VIX hovering near multi- year lows, is the market adequately pricing in uncertainty related to politics (in the US and abroad), the Fed’s intentions, and the sustainability of ultra-low interest rates?” Emanuel said. “Unlikely.”
“[W]e believe most investors have decided to minimize the importance of fundamental investing and instead are consumed with following the herd, chasing performance and not questioning consensus,” BMO’s Brian Belski warned. “These are the same investors, in our view, that believe that there is no way the Fed can raise rates before the election, that the US cannot grow without the rest of the world coming along as well, and that Mrs. Clinton’s future presidency is a slam dunk.”
In other words, investors seem pretty sure about the outcomes of all of the catalysts we listed above.
“If there is one thing we know for certain — nothing is certain within an investing climate, culture and landscape that are being bullied by regulation, compliance, doubt, and the overarching fear of not wanting to be wrong,” BMO’s Belski said. “Therefore, as markets enter the last four months of 2016, there remain more questions than answers in our view — issues that may indeed challenge the low volume new price highs that were scored this past summer.”
Assuming everything goes right, the markets and the economy may close out the year just fine. But should something go wrong, it would appear the markets are unusually vulnerable.
Sam Ro is managing editor at Yahoo Finance.