Momentum Slows in September

As investors return from the long Labor Day weekend, the month of August draws to a close with a positive - if volatile - statistic. The market (SPY) rose by +2.43% on the month, following an abrupt -6.48% drawdown which took only 10 calendar days to fully recover.

Since then, the S&P 500 has hovered around all time highs, just shy of setting a new record close. In contrast, the Nasdaq is still -5% below its July ATH, the Russell 2000 is -2% off its recent peak and the Dow Jones Industrial Average is the sole major index to set a high watermark. Overall, the backdrop is positive and arguably bullish on a medium and long term -- but trading conditions are overbought, as they always are near record highs.

September seasonality suggests that some weakness lies ahead, especially given such a good recent run for the equity markets (SPY is up nearly +20% year-to-date after all -- even if we stay flat by the end of December, it would still go down as a great year for stock returns). Yet September stands out as month for a couple of reasons: the Western World gets back to work after the summer holidays, trying to make the last 3 business months of the year count toward annual bonuses. For some reason it’s also historically the worst month for stock markets and the sole negative return month since 1964.

Trading in a Presidential Election year doesn’t improve the odds of getting positive returns September through October. Historically, we are noticing a pre-election dip, followed by a relief rally in November and December. It’s certainly been the case in the last couple of years, with the S&P 500 losing -4.2% on average in the past 5 years during September -- with the back half of the month being the most volatile.

Part of the seasonal weakness may be explained by supply and demand dynamics. Corporate share buybacks, which supported the rally from the recent lows, will begin to fade starting September 5th, as the buyback window starts to close ahead of Q3 Earnings Season. This window will be almost fully closed by the end of the month, partially explaining why the last 2 weeks of September are the worst on record.

This trend is predictable because it is closely linked to corporate earnings reports. There are three primary reasons why most companies implement a ban on share buybacks approximately one month prior to their quarterly earnings announcements.

1. Insider Trading Issues: Employees have access to confidential information about earnings. Thus, the ban helps to mitigate the perception that the company might be trading its stock based on this insider knowledge.

2. Investor Sentiment: Investors may become suspicious if a company is actively repurchasing its shares right before earnings announcements. If investors attempt to replicate these purchases, it could lead to increased volatility in the stock.

3. Regulatory Risks: Although there are no SEC regulations prohibiting share buybacks before earnings reports, most companies prefer to prevent an SEC investigation that could arise if there are suspicions of insider trading related to stock repurchases.

Secondly, it’s not uncommon for fund managers to de-risk their portfolios ahead of the upcoming elections - a volatile event in and of itself, specially given the current political climate, where accusations of fraud can potentially destabilize a peaceful transition of power.

Given persistently low levels of liquidity during the latest rally, any supply - demand related move will have an outsized impact on prices (at least until transaction volume returns to normal).

Meanwhile, at the Factors level, some broad based strength is apparent. All of the ETFs that we track are trading above all key moving averages, a disposition telling of short term overbought conditions. Notice that the only factors oversold relative to SPY are the Nasdaq (QQQ) and Foreign Developed Markets (EFA). Investors are basically rotating from “Large Cap Growth / Tech” to “Everything Else” - and this rotation is not yet over. As the market cap weighted S&P 500 is largely dependent on the big tech names to generate returns, such a rotation is not especially friendly for an ETF like SPY. Instead, the Equally Weighted S&P500 ETF (RSP) is poised to benefit.

Given all of the above, we are likely to experience a consolidation or correctionary period in the weeks ahead. The timing of such a move is always tricky, as the specific catalyst for the pullback is hard to pinpoint beforehand. While markets can make all-time highs soon, declining momentum and relative strength points to a retest either of support near the 50-DMA ($547) or the recent lows near $520 on SPY.

On a longer term basis, a more significant correction would present a viable buying opportunity. Our preliminary findings and 2025 year ahead projections for the S&P 500 validate the latest assumptions from Wall Street analysts. Namely that we could see 2025 EPS reach $260-$280, and valuations at 22-24 P/E multiples. This would place the 1 year Price Target on SPY between $572 and $672, implying an average upside of +9.5% from the latest close.

Usually, when the average upside exceeds potential double digit returns (as would be the case given a pullback in September), increasing equity risk exposure makes sense.

There is always the risk of a more pronounced drawdown in the event of an “unexpected, exogenous event that no one could have predicted”. Such an event could cause a fast liquidation cycle, as we’ve seen most recently in the yen carry trade mini blow-up. This is the reason why we are using active risk management techniques for our Portfolio Management.

However, a true bearish catalyst is not on the horizon at the moment, and it’s hard to argue against equity ownership at this point, despite elevated valuations. While “everyone is on board” for the long term treasury trade, there is still plenty of skepticism when it comes to stock returns.

Our Trading Strategy

We will soon publish our comprehensive Market Outlook for Q3 2025, with the updated 1 year price targets for the S&P 500. So far, our preliminary findings are surprisingly bullish. Our models are suggesting upside can reach almost +20% for the equity market from current levels.

Maintaining a healthy allocation to the equity market for now is fine, but a better entry point for increasing risk exposure is likely to be found in the future. A balanced approach is probably the best way to go at the moment. After all, the poster child for mega-cap momentum investing (NVDA) looks to be undergoing a consolidation pattern. Whenever NVDA finds a bottom, the broad market will most likely bottom out as well.

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