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Stepan Lavrouk
Stepan Lavrouk
Articles (255) 

The Dog Days of Summer

Is late summer actually a poor time for stocks?

August 20, 2019 | About:

Summer is an odd time of year. The weather is hot, no one is working and everyone should be relaxing. And yet somehow August always seems to throw up some adverse market event. In this latest note from Morgan Stanley’s (NYSE:MS) chief equity strategist, we examine why this is, and what the dog days of summer may have in store for us this year.

What’s the deal with late summer?

It’s a commonly held belief that the back-end of summer is a poor period for stocks, but is this actually true? As it turns out, yes:

“Over the past 100 years, September has been the worst month for the stock market. However, over the past 10 years, August has taken the throne as the worst month of the year ... Part of the reason why these two months are the weakest is due to the fact that many market participants are on vacation, reducing the market’s overall liquidity. This can lead to higher volatility than normal if the market sells off for fundamental reasons.”

Markets are ultimately just the sum total of the actions of millions of individual participants. Sometimes the reason stocks go down is as simple as “All the traders were on holiday.”

What do we have to look forward to?

Amid all the concern about the Federal Reserve’s rate cut, investors may have lost sight of some important fundamental matters -- poor economic data, weak earnings and the escalating U.S.-China trade war. Now, another issue has reared its head:

“Due to the passage of the higher debt ceiling by Congress, the US Treasury will now have to raise money to fund it. This means close to $150 billion of additional bill issuance in the month of August alone. That will definitely reduce liquidity in the market for other assets, and only exacerbate the risk for higher volatility during the month. Therefore, despite the strong rally last Thursday, I remain steadfast in my view that the US equity markets remain at risk for at least a 10% correction during the third quarter.”

The note stated that such a sell-off would impact high-flying growth stocks that are “priced for perfection and little disappointment,” and that defensive stocks and high-quality bonds, while also expensive, would likely retain their valuations longer. The note went on to describe a number of scenarios that could follow:

“The next catalyst for the correction to continue will likely be more disappointing economic data, and commentary from companies realising they need to cut costs further to offset the disappointing demand trends we see in most end markets. If these cuts start to come in the form of layoffs, the market will surely start to consider the risk of an economic recession as greater than what’s currently priced. Watch for more restructuring announcements as an early warning sign it’s starting.”

In other words, while poor data is currently not translating to the actual economy (just markets), it is only a matter of time before businesses are forced to wake up and take note of it.

Disclosure: The author owns no stocks mentioned.

Read more here: 

Howard Marks: Why Is Understanding Risk Important? 

General Electric Is 'One Recession Away' From Bankruptcy 

3 Ways US-China Trade Tensions Could Continue to Develop 

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About the author:

Stepan Lavrouk
Stepan Lavrouk is a financial writer with a background in equity research and macro trading. Specific investing interests include energy, fundamental geoeconomic analysis and biotechnology. He holds a bachelor of science degree from Trinity College Dublin.

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