/ September 02 / Weekly Preview
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Tuesday:
ISM Manufacturing PMI (49 exp.)
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Wednesday:
JOLTs Job Openings (7.4M exp)
Factory Orders MoM (-1.4% exp.)
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Thursday:
ISM Services PMI (51 exp.)
Initial Jobless Claims (230K exp.)
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Friday:
Non Farm Payrolls (75K exp.)Unemployment Rate (4.3% exp.)
Participation Rate (62.2% exp.)
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Monday:
N/A
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Tuesday:
Bank Of MontrealMongoDB, Inc.
Okta, Inc.
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Wednesday:
NVIDIA Corporation
CrowdStrike Holdings, Inc.
Snowflake Inc.
Veeva Systems Inc.
Agilent Technologies, Inc.
HP Inc.
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Thursday:
Dell Technologies Inc.
Marvell Technology, Inc.
Autodesk, Inc.
Affirm Holdings, Inc.
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Friday:
Alibaba Group Holding Limited
September Blues
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August turned out to be completely atypical for investors who were expecting a bout of seasonal weakness to go with thin liquidity and increased volatility while most were still enjoying vacations.
Over the last 30 years, August delivered some of the poorest monthly returns for the S&P 500, but last month completely defied history. Out of the last 10 years, since Q3 started in June, we’re now officially recording the best track record of any of the previous years, with SPY up +9.17% since the start of June (versus a median of just +2.45% for the whole quarter). While the gain for August was modest, the rally on which the performance was built upon is certainly notable.
A key driver which helped underpin the market’s run (especially since the March-April lows) have been Share Buybacks (we can find these under the category “Cash from Repurchase of Equity” in our metrics selector). Notably as August ended, so did the support from this factor, now down to one of the lowest levels on record during the past 3 years.
There is a “buyback blackout period” occuring in September, then repurchases typically re-start in October.
There was also tremendous corporate spending on AI capacity, which naturally fueled both mega caps doing the spending as well as mega caps benefitting from the capital outlays (the logic might be questionable, but the returns aren’t).
The keywords appear to be “mega caps”, but the best performing factor for the quarter was in fact IWM, the iShares Russell 2000 ETF, tracking small caps. Though both large and small caps posted a better quarterly performance than SPY, small caps were boosted by the “soft landing” narrative which sets up a supportive economic environment going forward.
To that end, July’s PCE inflation figures eased slightly, increasing investor confidence that the Federal Reserve will start easing monetary policy in September.
While this acted as a boon for small caps (due to them being the most economically sensitive group of companies), historical evidence points to not so great returns whenever IWM outperforms SPY dramatically on a 3-Month rolling interval.
In the chart below, we’ve plotted 3-Month Relative-to-SPY returns for IWM, with signals generated every time the series goes above 1.1 standard deviations (> 86% occurrences). With the exception of the 2021 easy money era, ALL of the signals that were triggered point to a loss of subsequent performance for small caps.
The median returns for IWM after a signal is triggered (excluding 2021) are barely positive at the 3-Month interval and -6.13% at 6-Months. In other words, the market is either setting up small caps for a roaring “easy money” rally, or the trade risks unraveling dramatically (in relative to SPY terms at least).
In Q3, institutions largely sold the first part of the rally up to early July, then flows stabilized. The August 1 dip was bought by large traders, signaling potential support for SPY at around $620. With share buybacks paused for the immediate future and large traders sidelined, it falls on retail investors to support the market in September.
UBS Markets posted a great analysis on the groups of equity holders at the moment. It basically says that retail traders comprise just over 40% of the U.S. stock market — in direct holdings alone. If we include pension funds, then the share surpasses 50%.
Relative to their disposable income, stock holdings are estimated at 265%. The previous high was recorded at 243% in 2021. This has the makings of fragility all over it, since retail traders could “crack under pressure” if the market turns lower — given the very high level of holdings relative to disposable income.
Technically speaking, the market is maintaining a bullish posture, with support just below the last close price in the form of the 20 and 50 DMAs (around $628 - $638). We’ve also seen previously that institutional traders stepped in to support equities at around $620 — this would be our floor for a September slowdown / consolidation.
We are also seeing signs that the rally is slowing. GEX has flipped negative for both SPY and QQQ in the short term, increasing the odds of higher volatility this week. The stochastic oscillator has also cooled from previous levels. Lastly, the MACD indicator has flipped negative and has also continued its lower and lower trend. All of this is not to say that the market is risking a “crash”, but a consolidation or pullback to support has high odds of materializing at the moment.
Breadth, or the number of stocks participating in the rally, has improved recently (65% of the market sits above the 50-DMA). Realized 1-Month volatility for the average stock in the market remains low, at around 9%, consistent with historical stretches of bull market advances. However, it’s these low plateaus in realized vol that sets up the next outburst, and it’s usually when volatility hedges are best bought.
Our Trading Strategy
Putting everything together, we can conclude that the market remains healthy, if overbought on the small caps side which risk a rotation trade.
There are clear seasonal headwinds upcoming, with share buyback liquidity drying up and a general lack of interest from institutions in supporting the market higher. They’ve signaled their intention of buying dips, however.
A modest decline to the 50-DMA would actually be a healthy development in our view. It would allow a cool-down and reset of some exuberant parts of the market and set up the stage for stronger conditions into year-end.
The pullback could be painful if compounded by retail traders panic selling, so a degree of risk management is always prudent to have in place.
We are monitoring the developments in the small caps space, especially as they react to this week’s main fundamental release - the BLS jobs report on Friday, which is going to be prefaced by the JOLTS figures tomorrow.
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