Volatility Returns to the Market
What goes up, must come down. Since 1950, September has been the worst month of the year for stocks on average. Moreover, when August is a particularly strong month, September usually counteracts with an especially bad market performance.
Given the exuberant August the markets enjoyed this year, it’s somewhat unsurprising that September brought the first meaningful correction in this new bull market. The month started off with the S&P 500 at the highest level in human history, and ended with the first monthly decline since the March market crash—with the S&P 500 declining by 3.9% for the month.
When the market began its recovery, retail investor speculation in call options surged. In fact, retail investors accounted for as much as 25% of the stock market’s activity in the Summer months of lockdown, compared to just 10% of the market in 2019.
Japanese conglomerate Softbank joined in the market frenzy, attempting to exploit the added liquidity in the options market by aggressively buying billions of dollars in call options on popular tech stocks, essentially betting that those shares would keep rising higher. The dealers that sold Softbank the call options had to buy the underlying stocks in order to hedge their position, which sent the prices of those tech stocks higher — so it essentially became a self-fulfilling prophecy. However, Softbank’s massive bets inflated the value of these stocks to unsustainable levels, thus making them ripe for a correction.
In September, the S&P 500 dropped 10% from its all-time high, led by a 14% decline in the tech-heavy Nasdaq 100.
So, will the markets be spooked in October? It’s historically the second worst-performing month of the year for stocks. However, there’s still some hope — data has shown that the markets tend to rise 70% of the time following particularly dismal September performances of at least -3.5%.
Secondly, winter is coming in North America. This could mean a second wave of COVID-19 and potentially more strict lockdowns, which have had irksome effects on economic recovery.
The rollout of a possible vaccine still remains uncertain, and there is still no consensus agreement on an official treatment for the virus.
And finally, we have the US election itself. This is perhaps one of the most unprecedented elections — with uncertainty around both the election outcome and the election process itself. It is unclear whether finalized results will be known within days, weeks or through acrimonious court battles which could take months.
As a result, expect volatility to remain high for the next 4-6 weeks, creating what is likely to be a difficult trading environment with a wide band for the major index averages.
Note also that there’s a tendency for the market to perform better when the incumbent party wins than when the incumbent party loses. The trends have been amplified under Republicans — with the strongest gains usually coming when incumbent Republicans have won and the biggest losses when incumbent Republicans have lost. However, election year weakness in stock market performance when Republicans have lost the Presidency have usually reversed in post-election years.
Investors’ biggest fear about a Biden win is a Democratic clean sweep that leads to higher taxes. The Biden campaign has promised to raise corporate taxes from 21% to 28%. This could reduce S&P operating earnings by 4.2%, disrupting—but not reversing—the fragile profits recovery.
All things considered, it’s quite likely that volatility may haunt the market this October.
Short term investors should consider adding gold to their portfolios, as a means of diversification and to hedge against the political uncertainty. It’s also recommended to have stop-losses implemented to protect your portfolio. However, longer-term investors should welcome these dips in the market, and consider them as an opportunity to buy quality stocks or ETFs, which can be expected to perform well once the economic recovery gains strength.
Originally published in the Trinidad and Tobago Business Guardian Newspaper on behalf of ANSA Merchant Bank Limited.
The information contained in this article is not intended and should not be used or construed as an offer to sell, or a solicitation of any offer to buy, securities of any fund or other investment product in any jurisdiction. The information in this article is not intended and should not be construed as investment, tax, legal, financial or other advice. Past performance is not indicative of future performance.
