For those who are still long, Friday brought chilly tidings. Big drops in the S&P 500 and Nasdaq 100 indexes. A meme-stock
dump. Data from Wall Street trading shops showing hedge funds were warming up to their shorts again — and that those shorts were making money. A basket tracking bearish-speculator favorites slid more than 6%, bringing its weekly drop to the most since the March 2020 crash.
The pressure to figure it out soon is high after a $7 trillion rally broke out in the middle of the Federal Reserve’s stiffest rate-hiking campaign in a generation. Feeding arguments to let stock bets ride are solid earnings and chart patterns suggesting the gains may last, including the S&P 500
erasing half its bear-market losses, a feat with an improbably sound record of success. Less encouraging is that September is the roughest month on shares, that the Fed may want the rally to go away and that nobody can tell if a recession will be dodged.
The choice is also somewhat of a referendum on how seriously to take investors’ current high threshold for pain. While history shows Northern Hemisphere autumns are when many rallies die, history has never been faced with retail day traders who are capable of driving rallies in nearly insolvent stocks or pushing the S&P 500 up 9% in a month when the Fed is tightening. Old realities are running into new tactics. Something will probably have to give.
“I expect September to be volatile,” said Peter Tchir, head of macro strategy at Academy Securities. “The good news is trading desks will be fully staffed and we might see more liquidity in the markets, but the bad news is that any mispricings could be ‘corrected’ quickly.”
Not only is September the month with the worst S&P 500 average performance, it’s also the only month where stocks fall more frequently than they rise, according to Sam Stovall, chief investment strategist at CFRA. The index has dropped an average of 1% during the month, according to data compiled by Yardeni Research. Only two others — February and May — tend to see negative returns and neither are anywhere near as turbulent as September is.
Still, inflation hasn’t been this high in decades, and that makes the current cycle different, said Alex Chaloff, co-head of investment strategies at Bernstein Private Wealth Management.
“I don’t think that we can say, ‘Well, the fall is always tough.’ That is less relevant today,” he said. “If we get a continuation in a lower inflation reading, if we have a decent jobs report as far as net new added and have some wage growth — but not enough people think this will drive inflation — that’s the perfect recipe for a fall rally.”
Meanwhile, seasonality maxims haven’t held up this year, according to Kristina Hooper, chief global market strategist at Invesco. Performance since May isn’t as disastrous as the “Sell in May and go away” adage might have portended.
“I’m not sure this is a year that’s going to fit with historical patterns,” she said in an interview at Bloomberg’s New York headquarters. “Now, I don’t expect great things this fall, but I do think that the current stock-market rally is likely to be sustained and we might see the year-end a little higher than where we are today.”
Up almost 12% since the end of June, the S&P 500 is off to the best start of a third quarter since 1932. And though it fell 1.2% this week — its first week lower in five — it’s up 2.4% for the month so far.
Tchir says a big driver of volatility will be next month’s Fed meeting. Consumer-price reports as well as jobs data for August coming before then could help shape market expectations ahead of that decision. Policy makers are also heading to Jackson Hole, Wyoming, at the end of the month for an annual policy retreat.
Investors have been
ignoring increasingly thorny warnings from Fed officials, who have stressed they’re far from done with raising rates. San Francisco Fed President Mary Daly
said this week the central bank should raise interest rates “a little” above 3% by the end of the year, pushing back against investor bets that officials would then reverse course.
“I would expect the Fed to play a big role if we get a September swoon,” said Mike Bailey, director of research at FBB Capital Partners. “Earnings are out of the way until mid-October, so inflation and Fed action will be center stage until then.”
Bearish traders, crushed in the July-August rally, are showing signs of life again. And hedge funds, which borrowed stocks to bet on further declines, this week either
stopped covering or started reloading on shorts, separate prime broker data from JPMorgan Chase & Co. and Goldman Sachs Group Inc. show.
September is also when a lot of portfolio managers return from summer getaways. “They come back from vacation, and they want to reposition,” Zhiwei Ren, portfolio manager at Penn Mutual Asset Management, said in an interview. “And the repositioning of portfolios will have big buy-and-sell flows.”