Investors fretting over signs the bull market in stocks is pushing toward unsustainable levels will soon have another thing to worry about.
The calendar turns next week to what has historically been the weakest month for US stocks, as institutional investors rebalance, retail traders slow their buying, volatility picks up and corporate buying goes dark.
While macro events are generally more determinant for the market’s direction, seasonal factors can exacerbate moves triggered by the likes of economic data or monetary policy. Next month, investors will have to grapple with the latest government hiring report and two readings on inflation before the Federal Reserve makes its highly anticipated policy decision. In the background is President Donald Trump’s continued criticism of the central bank’s independence as he clamors for sharp rate cuts.
Bulls roll into September in a particularly precarious position, given the S&P 500’s 17% surge since early May. Valuations have hit 22 times projected earnings, levels associated with the end days of the dot-com bubble. Computer-driven traders, whose strategies ignore fundamentals to focus on trends, are near maximum allocation to US stocks. And hedge fund equity exposure hit the 80th percentile in recent days, leaving positioning extended, according to Barclays strategists including Emmanuel Cau.
“We’re in a very dangerous spot,” said Brandon Yarckin, chief operating officer of Universa Investments. “It’s a difficult thing to navigate this market by owning diversifiers like bonds or hedge funds instead of being fully invested in stocks.”
The S&P 500 has fallen 56% of the time in September, by an average 1.17%, according to Bank of America Corp.’s Paul Ciana, who cited data going back to 1927. In the first year of a president’s term, the S&P 500 is down 58% of Septembers by an average of 1.62%. Futures on the benchmark index declined 0.4% as of 7:50 a.m. in New York.
Selling pressure is likely to arise from pension funds and mutual funds, as they rebalance portfolios at the end of the quarter. The largest exchanged-traded fund that tracks the S&P 500 has gained almost 5% since the end of June, while a broad bond ETF has lost nearly 2%. That equity outperformance could force selling as the month wears on.
Mutual funds, likewise, could begin rebalancing ahead of their fiscal year-end, selling laggards, or simply locking in gains, said David Cohne, mutual fund analyst at Bloomberg Intelligence. Larger funds tend unwind positions slowly so as to not roil the market, moves that could start next month, he said.
Retail traders are also likely to slow their torrid pace of stock buying in September. Citadel Securities’ data going back to 2017 showed that after a strong June and July, retail buying activity starts to slacken in August, while September typically marks the year’s low point for retail participation.
On top of that, one of the market’s biggest buying cohorts, US corporations, will be forced to cool purchases ahead of third-quarter earnings.
Another point of concern for investors is that September and October are typically the two months when volatility hits the highest level with the Cboe Volatility Index, or the VIX, trading around 20, according to Bloomberg Intelligence data going back to 1990s. It closed at 14.43 on Thursday.
In the options market, positioning shows that traders are already getting more cautious in the near-term. The cost of a 10 delta put versus a 40 delta put, which shows the cost of protection against a steep selloff versus a shallow decline, jumped to the highest level this year.
“We are still seeing a fair amount of hedging in September and October with the trend highlighting some caution in near-term downside,” said Chris Murphy, co-head of derivatives strategy at Susquehanna International Group.
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