It has become a truism that the most volatile months of the year for markets are those bookends of the northern summer of languor and largesse. The maxim that one should “sell in May and go away, and come back on St Leger’s Day” is attributed to the age-old custom of aristocrats, merchants and bankers who would leave the city of London and escape to the country during the hot summer months.
September is no less notorious. According to the Stock Trader’s Almanac, on average September is the month when the three leading stock indices usually perform the poorest, a phenomenon which has been dubbed the “September Effect”.
While this may be a result of traders coming back from their summer vacations and actioning moves after desks had been staffed by trainees through the sweltering New York August, or more prosaically due to big US mutual funds harvesting losses before their September tax year-end, or just a statistical coincidence, it is impossible to know.
However, investors who have exposure to equity markets would do well to take stock at this time of year as we look ahead to the final quarter of what has been an extraordinary year in markets.
The week has shown that there is no shortage of optimism that abounds. After a dreadful first half of August, everything rebounded this week, be it Chinese equities or commodities. As the US Food and Drug Administration granted full approval to the BioNTech-Pfizer Covid vaccine, worries about the effects of the Delta variant on growth and the Fed tapering monetary stimulus measures have receded. Once again, we are at record highs.
At the same time it seems that the data coming out of the major global economies are only getting worse. US and international data releases over the past few weeks have missed forecasts at an increasing rate, highlighting the risk that the Delta variant will indeed have dire effects on the global economic rebound.
Recent US data have underwhelmed economists’ predictions while more recently these reports have started missing the mark by the greatest degree since the pandemic, according to an economic surprise index collated by Citigroup. US consumer confidence has fallen sharply, while retail sales and new home construction numbers have disappointed.
A similar dynamic is happening outside of the US. While still strong, European business sentiment is lower and below forecasts, and UK retail sales figures for the usually strong month of July were dire. Citi’s monitor of the Chinese economy is even bleaker, with retail sales and industrial production figures undershooting.
What is happening here? Why are equity markets lagging behind the economic data? Should it not be the other way round? The world’s economy and its stock markets could hardly be more divergent. The war against cliché prevents me from citing the first sentence of A Tale of Two Cities, but it feels apposite.
The reality seems to be that the disconnect between the real economy and stock market valuations has never been greater. Investors would do well to ask whether indeed global equities bear any relation to anything happening inside actual companies, as opposed to solely what sounds are emanating from deep within the Federal Reserve of the United States.
It would seem in this back-to-front world that bad news coming out of the US economy is paradoxically good for equity markets, as it is likely to postpone the eventual day of reckoning of removing the punch bowl at the party. Investors positioning themselves ahead of the annual Jackson Hole central banker symposium seem to be betting that Fed Chairman Jerome Powell will, as expected, err on the side of caution and delay tapering.
However, as we have said so many times through this most unloved bull market, at some point valuations must revert to normality. Barring some totally unforeseen Black Swan event there is nothing on the immediate horizon to trigger a market meltdown, therefore as long as central banks underpin the most rapid stock market recovery in history, September may turn out to be a rather dull month in markets after all. Perhaps therefore the fate of global equities is not that there will be a sudden correction and reversion to mean, but that the unprecedented largesse of monetary profligacy has meant that the next 10 years of economic progress has, due to near zero interest and discount rates, all been priced in upfront.
Investors therefore should not be surprised if in five years’ time markets are roughly where they are now. Maybe we do not merit a magnificent conflagration, just an extended period of purgatory. As goes another axiom: the end of the bull market is not when there is no new good news, but when the good news is slightly less good than it was before. BM/DM