Managing The September Curse

You may see a few articles such as this one about the poor stock market returns that tend to occur in September.  As the article points out, September can be a trying month that ends with negative returns. Add in tropical storms and North Korea tensions and we can see why professional investors become nervous.  While I don’t try to forecast the weather or geopolitical events, I do assess the market’s ability to recover quickly from whatever events do take place by virtue of the market’s inherent resilience.

The investment process used to create the Focused 15 Investing model portfolios systematically evaluates whether it makes sense to reduce exposure to the stock market for the month of September. At the end of August, it will reduce exposure to stocks if the Micro MRI is higher than a specific threshold. If this condition is met, I expect price movements to be negative in September and for prices to remain low for some time. The process then takes some money out of the market. The rationale is that if the Micro is at a high level and is likely to turn negative in September and cause assets to be taken out anyway, do not wait for the turn negative event ― just reduce assets at the end of August.  This decision rule would not be in the process if it didn’t add value over the last 100 years.  Indeed, since 1918, these specific conditions have been met in 43* of the 100 years. This “conditional price movement” technique for September adds about 1.67% on an annualized basis over 100 years, which is a respectable amount.  This type of conditional technique working with the MRI information is important to the investment approach. So important, in fact, that I named my firm CPM Investing, for conditional price movement.

During the evaluation this recent August, the conditions were not met, and there was no change in the target weights. The Micro MRI for stocks was already quite low, which means that the market is closer to making a short-term move higher. After any decline in September, the market will most likely follow the trend indicated by the Macro MRI, which is positive at this time. While September may be bumpy, no change in target weights is justified.  

Current Market Environment

As a quick reminder, I describe the Market Resilience Indexes in a footnote[1].

A. Stock markets…

Most major stock markets around the world have strong and positive Macro (long-term) MRIs. This indicates that the longer-term price trend is still positive. The DJIA has proceeded further along this positive trend than other major markets and is therefore closer to the inevitable end of the positive trend. However, for the time being, the trend for the DJIA continues to be positive. Most major stock markets around the world can recover quickly from declines related to the near-term events. If the positive Macro MRIs were absent, the potential for a quick recovery would be greatly diminished. 

Their Micro MRIs have been in the downward leg of their cycles for several weeks and are not providing any resilience to negative news.  This state indicates short-term vulnerability, and we have been seeing higher price volatility over the last several weeks as a result. Importantly, the Micro MRIs already descended to low levels by the end of August. As of last Friday (September 1st), the Micro for the DJIA is at the 35th percentile since 1918, which is a moderately low level – 65% of the weeks since 1918 have higher levels. And it is trending lower. Other markets have even lower levels, as shown below. The lower the percentile rank, the more the market has already descended to short-term lows.
a.      DJIA – 35th percentile
b.     DJ and S&P Industrial Sectors – 11th (the “industrial sectors” are more domestically focused than the DJIA listed above)
c.      Russell 2000 – 22nd
d.     DJ Transports – 11th
e.     NASDAQ – 24th
f.       UK Stocks – 14th
g.      Europe – 14th
h.     Japan – 14th

As you can see, the major stock markets were at relatively low levels as of last Friday. They are likely to shift to a positive reading and provide short-term resilience over the next few weeks. If the curse of September, the storms, and the North Korea tensions occurred when these values were higher, say at the 80th percentile or higher, the downside would be greater and the condition described earlier would have been met.

The net effect of the current condition is that while the markets may decline with the news of the day, they are likely to recover quickly. This leaves little opportunity to exit and re-enter the markets.

B. US 10y Treasury Bond Futures (TY1)

The Macro MRI is trending lower and is at a low level (7th percentile since 1986) and the Exceptional Macro appeared recently (8/18/2017).  Both suggest that the Macro may shift to a positive state in the coming weeks or months.  These longer-term indicators highlight the potential for a strong move higher – one that is beyond what might result from near-term fears linked to the news of the day.
The Micro MRI, which measures shorter-term resilience, has been trending positive for several weeks. It is at the 43rd percentile since 1986 and can continue higher for several weeks. The net effect is more resilient bond prices over both shorter and longer horizons. 

C. Commodities

The SPGSCI continues to be rated 3 (highest resilience), but this rating has been borderline for several weeks. Its Macro has been trending positive but is very shallow; it could easily move negative and cease to provide resilience. The Micro MRI is at a high level (80th percentile since 1973) and may cease over the next few weeks. Thus, the 3 rating continues to be borderline and at risk.  

D. Dollar (DXY)

DXY is experiencing only Micro (short-term) resilience. Its Macro and Exceptional Macro are not close to turning positive. The Micro MRI is at the 15th percentile since 1970 and could continue to be positive for several weeks. However, DXY’s Micro has been erratic over the recent period (beginning in roughly April); it has shifted between being positive and negative over this time period. Furthermore, its Macro is at a relatively high level, which suggests that there is more downside to DXY than upside.

* An early version of this post indicated 67 years in which the conditions had been met.  Of those, 43 were for the September declines and 24 were for March declines.    

[1] I use proprietary metrics to determine where current price levels are relative to their historical norms. The Market Resilience Indexes indicate where prices are relative to their long-term (Macro) and short-term (Micro) historical cycles and whether they are moving toward their historical peaks or troughs.  Cycles for the Macro MRI last several quarters to multiple years.  Cycles for the Micro MRI last four to six months.  The presence of the Exceptional Macro MRI indicates that the Macro MRI is likely to move from a negative trend to a more positive one.