Strong Economic News Supports Stocks
Despite a tough start to the month, stocks advanced sharply in August. Globally equities gained roughly 2.50%, with the United States and emerging markets posting the strongest returns. Last week contributed to the gains, with the S&P 500 closing above the 2,000 threshold for the first time – 16 years after first crossing the 1,000 level.
Strong economic data helped push stocks higher as last week brought still more evidence of a recovering U.S. economy. The majority of the U.S. data were strong, with the notable exception of still sluggish spending and income – personal spending in July unexpectedly dropped for the first time in six months. But second quarter gross domestic product (GDP) was revised higher, with fixed investment increasing at its fastest pace since the third quarter of 2011. And in another sign that lower mortgage rates are supporting the housing market, pending home sales rose by 3.3% last month. In addition, stocks were supported by continued mergers and acquisition activity and stubbornly low long-term interest rates.
That said, as we enter the fall investors should be aware of two issues.
First, conditions are ripe for further increases in volatility . Average daily volatility was approximately 15% higher in August than the previous three months, although it fell over the course of the month. To the extent strong economic data continue, one side effect is likely to be a heightened focus on an initial rate hike by the Federal Reserve. Marginally tighter monetary conditions are likely to support the trend towards somewhat higher volatility. In addition, geopolitical risks are still festering. Although investors are increasingly turning a blind eye to the escalating conflict in the Ukraine, to the extent the situation continues to deteriorate, this is likely to produce an abrupt reversal in momentum for stocks.
Second, we are approaching an historically soft period for equities. Generally, we put little faith in seasonal biases, as most turn out to be just statistical noise. September, however, appears to be different. Looking back at over 100 years of U.S. data, September stands out as the one month with a statistically significant record of poor stock performance. What is interesting is that this trend occurs not just in the U.S., but in markets as far afield as Germany, the U.K. and even Japan.
Still, a strengthening economy, low inflation and moribund Treasury yields suggest that stocks can and probably should move higher by year’s end. But in the near-term, negative seasonality and complacency over growing geopolitical risks recommend that investors exercise a bit of caution going into the fall.