Multiple risks overlapping raise concerns about the bull market outlook; U.S. stock bulls face severe tests in September
Before the Federal Reserve makes its policy decision, investors face multiple risks, including the latest employment and inflation data. The U.S. stock market enters its historically weakest month, institutional investors are adjusting their positions, and retail traders are slowing their buying, leading to increased market volatility. The S&P 500 has risen 17% since May, with valuations reaching 22 times, close to the levels seen at the end of the dot-com bubble. Analysts warn that the probability of a decline in the S&P 500 in September is 56%, which may face selling pressure
Investors worried about signs that the bull market is pushing towards unsustainable levels will soon have new troubles.
According to Zhitong Finance APP, as the calendar turns to next week, U.S. stocks will enter the historically weakest month—institutional investors adjusting positions, retail traders slowing down purchases, increased volatility, and corporate buybacks entering a quiet period.
Although macro events usually have a more decisive impact on market direction, seasonal factors may exacerbate volatility triggered by economic data or monetary policy. Next month, before the highly anticipated policy decision by the Federal Reserve, investors must contend with the latest government employment report and two inflation data releases.
In this context, U.S. President Trump continues to criticize the independence of the central bank while calling for significant interest rate cuts.
The situation for bulls entering September is particularly precarious, as the S&P 500 index has surged 17% since early May. Valuations have reached 22 times expected earnings, comparable to levels at the end of the dot-com bubble. Computer-driven traders' allocation in U.S. stocks is nearing maximum levels, with their strategies ignoring fundamentals and focusing on trends.
Barclays strategist Emmanuel Cau and others point out that hedge funds' equity risk exposure recently reached the 80th percentile, with positions at high levels.
Brandon Yarckin, Chief Operating Officer of Universa Investments, stated: "We are in a very dangerous situation. Navigating this market by holding diversified assets like bonds or hedge funds, rather than being fully invested in stocks, is a difficult task."
Bank of America’s Paul Ciana cited data dating back to 1927, indicating that the S&P 500 index has a 56% probability of declining in September, with an average drop of 1.17%. In the first year of a presidential term, the probability of the S&P 500 index declining in September is 58%, with an average drop of 1.62%.
Sell-off pressure may come from pension funds and mutual funds, as they adjust their portfolios at the end of the quarter. The largest exchange-traded fund tracking the S&P 500 index has risen nearly 5% since the end of June, while a broad bond ETF has fallen nearly 2%. This strong performance in stocks may force funds to sell off later this month.
David Cohne, a mutual fund analyst at Bloomberg Industry Research, noted that mutual funds may also rebalance before the new fiscal year begins, selling underperforming assets or simply locking in profits. He pointed out that large funds tend to unwind positions slowly to avoid disrupting the market, with related operations possibly starting next month.
Retail traders may also slow down their fervent stock purchases in September. Data from Castle Securities dating back to 2017 shows that after strong buying activity in June and July, retail buying began to slow in August, and September is typically the low point for retail participation throughout the year In addition, one of the largest buying groups in the market, American companies, will be forced to reduce purchases before the third-quarter earnings reports are released.
According to data from Bloomberg Industry Research dating back to the 1990s, another concern for investors is that September and October are typically the two months with the highest volatility, with the Cboe Volatility Index (VIX) trading range usually around 20. The index closed at 14.43 on Thursday.
In the options market, positions show that traders have become more cautious about short-term trends. The cost ratio of 10-delta put options to 40-delta put options (reflecting the cost comparison of hedging against significant sell-offs versus moderate declines) has surged to its highest level this year.
Chris Murphy, co-head of derivatives strategy at Susquehanna International Group, stated: "We still see a lot of hedging activity in September and October, which highlights a cautious attitude towards short-term downside risks."
