The month of September started in positive territory during the first three trading days. Is it time to pop the champagne bottles?
With a sudden change in market dynamics, investors have injected additional capital into the market over the past week. Over 60% of all stocks traded below their 50-day simple moving average two weeks ago. On Friday (September 3), that figure fell to 40%, according to Finviz.
This is a big change in feeling in a short period.
What happened? Today I will describe three main factors that lead to higher sentiment. However, I want to make one thing clear before I do so. Historically, September has been the weakest month for financial markets. This means that despite the positive sentiment, we could experience a sharp turnaround.
Let’s dive into the macro trends to start our week.
Fed makes statement
In mid-August, investors predicted that the Federal Reserve would begin the process of reducing its balance sheet by $ 9 trillion at the next meeting of the Fed’s open market committee later this month. However, after the Fed’s annual symposium in Jackson Hole, Federal Reserve Chairman Jerome Powell announced that the central bank still had a lot of work to do.
This announcement helped to quickly propel capital into the S&P 500. Despite geopolitical concerns related to Afghanistan, markets quickly accelerated. The Fed may make some announcements about plans to cut its monthly $ 120 billion in treasury bills and mortgage-backed securities at the September meeting.
However, an aggressive cutback plan can be ruled out based on Friday’s jobs report and concerns about economic growth. Instead, the Fed is expected to start its process by cutting $ 10 billion a month in December. But there may be more flexibility on the part of the central bank.
Remember that any delay in the Fed’s tapering, or even a smaller reduction in its purchases than expected, will prolong the flow of new capital into the economy. Additionally, given the relationship between the Fed’s balance sheet and the S&P 500, there appears to be more potential.
A psychological level finds support
The market has an unusual psychological trend. The recent run to 4,500 for the S&P 500 has been a critical test of sentiment and resistance. Almost immediately after the S&P 500 hit this level on August 27, investment banks began to raise their targets for the coming year. UBS recently forecast the index to reach 5,000 by the end of 2022.
This level of 4,500 did more than just instill confidence in a future race to the market.
The volumes have grown quite rapidly. According to FactSet, the number of shares traded each day on the SPDR S&P 500 ETF (SPY) totaled around 54 million during the last week of August. As of mid-month, that figure was less than 50 million shares traded.
We have also seen a wave of capital returns in the more than 8,000 stocks traded in the markets. For example, the iShares Russell 2000 ETF (IWM) traded sideways from March to August.
This index represents 2,000 companies belonging to the small cap space. The sideways trend results from negative trends that have fueled capital from value stocks and small cap stocks to larger cap stocks.
But the recent reversal in market dynamics has fueled a wave of capital returning to small, nano-cap and micro-cap stocks. As you can see in the Finviz chart below, these share classes (by market cap) had a great week to start September.
Washington remains paralyzed
The last factor that continues to fuel high volumes is the paralysis in Washington. Domestic politics have indeed hit a wall in Washington. While a smaller infrastructure package has passed through the Senate, the likelihood of bipartisan cooperation on a far-reaching bill is fleeting. The closer we get to 2021, the closer we get to next year’s midterm elections.
With the Senate split 50-50 and Democrats holding the House of Representatives by just two handshakes, a radical policy change that would affect the economy or the stock market appears to be out of place. A tax code overhaul or massive tax hikes are not expected to happen in the coming months (or at least until 2024 at the earliest).
With no political surprises on the horizon and Democrats holding enough votes to raise the debt ceiling, investors have fewer worries for the year ahead.
Keep an eye on the past
Despite the positive recovery at the start of the month, we remain vigilant on the current market. As I noted, valuations are stretched, utility closed-end funds were recently trading above their net asset values, and other factors point to a foamy market.
In addition, September is historically the worst month for the stock market. Since 1928, the month has produced an average return of -0.1%. During that time, he enjoyed a win rate of just 46% in the same time frame. Given this historic factor, investors will still be worried about a slowdown later this month, regardless of recent positive catalysts.
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Originally posted on TradeSmith.com.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.