Compared to June and July, August was a rocky month for the stock market. The month opened with a downtrend and ended the last few days with some upside. Here are a few notes on the markets as we head into the month of September.
Lack of Outlier Days
One of the biggest positives in the markets right now is that there has not been any significant rise in volatility. Rising volatility is a bearish characteristic. One of the primary ways that you can visualize rising volatility is through the frequency of “outlier days.” If you have been reading our previous updates, then you already know that an outlier day is defined as a daily move of +/-1.50%. The S&P 500 has not experienced one of those since May. While outlier days are normal and expected to occur between 10-20 times per year in a normal market environment, a cluster of outlier days would be a sign that volatility is expanding, and the market is becoming less efficient and more inefficient. Even though the markets felt shaky in August, there were no outlier days experienced.
It should be noted that while volatility can be too high, it can also get too low. At Canterbury we quantify the market’s level of volatility using our own “Canterbury Volatility Index” (CVI). This indicator is used to gauge the market’s to “temperature.” Due to a lack of outlier days, volatility has been slowly declining. Right now, the CVI of the S&P 500 sits at CVI 58. Studies show that that as volatility declines to extreme lows (less than CVI 50), markets are more likely and can be prone to experiencing an “outlier” day. This is because declining volatility can be like “squeezing down a spring.” Eventually, the market will need to relieve the pent-up pressure.
While the markets struggled last month, the sectors that took the biggest hits were actually the ones that are often considered the most traditionally “defensive” or “risk off” sectors. Out the 11 S&P 500 sectors, the five worst performing sectors (worst listed first) were Utilities, Consumer Staples, Real Estate, Basic Materials, and Financials. While Energy was the only positive performing sector in August, investors showed that they still had some appetite for risk as Consumer Discretionary, Communications, and Information Technology performed above average for the markets sectors.
Lack of Volume
As stated in prior updates, August in the “dog days of summer,” meaning that it is usually a weaker month, but fluctuates on lower volume, which can be interpreted as lower conviction. While the decline in the month of August took place on low volume trading, there is some concern as to strength of the late-month rally. Four of the month’s nine “up” days came in the last five trading days of the month. Those four “up” days were the four lowest volume trading days for the month. There was not a lot of “conviction” in the rally to end the month.
September is Historically a Weak Month
August has historically been the third weakest month for the markets since 1950. September, on the other hand, has been the weakest, and historically has had negative returns on average. As a matter of fact, September is the only month to have more negative returns than positive ones since 1950 (about 56% of Septembers since 1950 have been negative).
Take this with a grain of salt. There have only been 73 Septembers since 1950. This is not enough data points to draw a statistically relevant conclusion. The weakness or strength of a particular month is largely dependent on what type of market environment is in place going into the month, whether it is a low volatility bull market or a high volatility bear market. While some seasonality does exist in markets, we wouldn’t put too much stock into predicting how a particular month will perform based on previous data, other than noting that September has historically been weaker.
August is typically a quiet, weaker month. Last month saw a decline, followed by a small rally to end the month, but that rally took place on low volume that could indicate low conviction. On the bright side, the sectors worst performances came in areas that are typically seen as more “defensive” sectors. Technology-related stocks, which make up a relatively large percentage of the markets, held up comparatively well in August. Additionally, there were no outlier days for the 3rd straight month.
Speaking of outliers, volatility is compressing. As volatility squeezes down, it would be more than likely to see an outlier day in the near future, given both the extended streak without an outlier and volatility levels nearing extreme low territory.
All-in-all, there have not been many rotations in the markets outside of a few industries. Our adaptive portfolio has made a few minor adjustments to accommodate some of those small rotations. One of those adjustments has been a rotation into the energy sector as it has started to look stronger from a technical standpoint.