September is the stock market’s cruelest month. That’s been the case since 1950. True to form, the market got off to a rough September start last week, which may be set to continue. Selling pressure was concentrated in the market’s 2020 darlings, above all in information technology.
Oddly, more economically and market sensitive stocks, such as financials and basic materials, outperformed the broader market index. Bond yields rose and the yield curve steepened, typically a sign that investors anticipate better growth ahead. However, energy prices dipped, and the dollar was little changed.
At first glance, it seems investors are willing to shift out of mega-capitalization growth stocks and into more cyclically sensitive sectors. That would be consistent with an improved economic outlook as reflected in a steeper yield curve.
There are reasons, however, to be cautious about cyclical rotation. Over the past week, for example, energy and consumer discretionary stocks slumped. Shares of industrial names also fell. Small capitalization stocks lagged behind large capitalization and low volatility styles. None of those outcomes is typical during full-fledged market rotation.
Last week’s global macroeconomic data were also not convincing.
On the positive side, the US manufacturing ISM index and its Chinese counterpart (Caixin) showed improvement last month. And the US employment report evidenced healthy gains in jobs and in the labor force participation rate, as well as a strong decline in the unemployment rate.
However, US job gains in August were padded by the addition of 238,000 census workers. Private sector jobs rose a healthy 0.9% last month, but that represented a slowing compared to the prior month’s 1.4% increase. And strong job gains mask the fact that millions of Americans (and workers in many other economies worldwide) remain furloughed, unemployed or under-employed relative to pre-pandemic norms.
Moreover, an array of indicators released last week, including Japanese consumer confidence, EU surveys of manufacturing, US factory orders, and services indices in China and in the US exhibited worrisome losses of momentum. Moreover, EU retail sales, Japanese capital goods orders and Japanese labor market data showed signs of outright declines in economic activity.
Meanwhile, prospects for US fiscal stimulus have dimmed. Senate Republicans have hardened their opposition to a renewal of $600 per week in supplementary unemployment benefits following the declines in US unemployment reported since mid-year. With both parties stepping up partisan campaigning in the final two months before the November elections, compromise becomes more difficult. Yet without some additional fiscal support, the economy – and consumption in particular – will struggle to maintain momentum in the final months of 2020.
Extreme market positioning is also a factor behind the latest market sell-off. The performance of the five largest companies by US market capitalization, which account for just under a quarter of the total valuation of the S&P500, have begun to dominate swings in major market indices. Recently, the performance of the broad market last week appears linked to profit-taking and the unwinding of derivative and leverage positions in those concentrated holdings, rather than a reflection of genuine rotation by investors into other styles and sectors.
Technical factors may continue to play an important role in the near term. Labor Day week is a short one in the US. Economic and policy calendars are also relatively light. Market performance will more likely be driven by momentum and near-term trading conditions.
Finally, investors should note that the news flow will become more dominated by pandemic news and political events.
Unfortunately, the pandemic shows few signs of sustainable slowing. Reported cases are rising again in countries that had previously seen declines, such as France, Spain or the UK. The US is experiencing ‘rolling outbreaks’ – just as some states successfully slow rates of infection others witness fresh outbreaks. Looking further ahead, the end of warm weather in the northern hemisphere and growing fatigue with pandemic control measures could lead to higher rates of infection, even as the upcoming flu season gets closer.
Political uncertainty is also likely to weigh more heavily on markets, above all as regards the US November elections. On most measures, the race for the presidency is tightening. According to composite polling, Biden’s lead nationally has shrunk from just over 9 percentage points prior to the party conventions to 7.5 points today. President Trump’s disapproval rating has fallen from a high of 56% in early July to a still-high 52.3% today. In key electoral college ‘swing states’, such as Pennsylvania or Michigan, Biden’s lead is also narrowing, albeit less so in Wisconsin or Arizona where the former vice president has maintained his edge.
Overall, the University of Iowa political futures markets indicate that Biden’s odds of capturing the White House have dipped from nearly 80% in July to 72% now. The same markets indicate that the prospects for the Democrats taking control of the Senate have slipped from over 70% two months ago to 57% today.
For broad swathes of the global population, 2020 has been a most challenging year. Despite a rocky first quarter, investors have had it much better. This K-shaped ‘recovery,’ where those who hold stocks and high-paying jobs are seeing their wealth grow rapidly (the upward arm), while pretty much everyone else is forced to endure high unemployment, job insecurity, and nonexistent wage growth (the downward arm), is no recovery at all. If it continues, it has the potential to supercharge the already unsustainable wealth divide and undermine what is at best fragile social cohesion.
But September may prove again a cruel month for stocks and begin to change the narrative. The bulls will cite highly supportive monetary policies, historically low interest rates and the lack of compelling alternatives as powerful supports for global equities. Yet, as noted above, technical factors, economic fundamentals, fiscal policy stances and sources of political uncertainty are shifting in ways that deserve attention.
September, and October, will probably contain a few nasty surprises. Get ready.
