A re­turn to volatil­ity

His­tor­i­cal anal­y­sis of the S&P500 sug­gests a buy­ing op­por­tu­nity may be on the cards

Financial Mail - Investors Monthly - - Analysis: Technical -

The S&P500 fi­nally had some volatil­ity re­turn­ing in the sec­ond week of Septem­ber. The world’s most closely watched eq­uity in­dex had been trad­ing in one of the tight­est trad­ing ranges ever for the two months be­fore, frus­trat­ing traders and in­vestors alike. Volatil­ity con­tracted to lev­els not seen in 25 years.

As with all volatil­ity con­trac­tions, it was never go­ing to last long. On Septem­ber 8 — when the S&P500 had not had a daily move of more than 1% for more than two months — the mar­ket sud­denly broke sharply to the down­side. The in­dex dropped 2.5% in one ses­sion, caus­ing volatil­ity to spike. The VIX volatil­ity in­dex jumped by 70% in three trad­ing ses­sions. The sub­se­quent four trad­ing days had moves of more than 1% each day.

The sharp break lower re­sulted in the S&P500 break­ing be­low an im­por­tant sup­port level at 2,160. That sup­port had been in­tact for the eight weeks be­fore.

The sud­den break to the down­side was ini­tially sparked in Europe. Euro­pean Cen­tral Bank (ECB) pres­i­dent Mario Draghi dis­ap­pointed hope­ful bulls by fail­ing to an­nounce any fur­ther mon­e­tary eas­ing. The mar­ket had been ex­pect­ing an ex­ten­sion to the ECB’s quan­ti­ta­tive eas­ing pro­gramme. It was not to be.

The sud­den drop on eq­uity mar­kets af­ter the ECB meet­ing il­lus­trated just how de­pen­dent these are on the stim­u­lus-driven eco­nomic en­vi­ron­ment with low — in some cases neg­a­tive — in­ter­est rates as well as cen­tral bank bond pur­chases. Any sug­ges­tion that the sta­tus quo may not last (it can’t) re­sults in mar­kets throw­ing a mi­nor tantrum.

The break be­low 2,160 sup­port looks to be rel­a­tively es­tab­lished now. The mar­ket had not man­aged to break above the 2,160 area again at the time of writ­ing, and had been bumping up against the un­der­side of that level un­suc­cess­fully on a num­ber of days. The 50-day mov­ing av­er­age comes in at the same area and seems to be of­fer­ing re­sis­tance to any rally.

It is not un­com­mon for the S&P500 to ex­pe­ri­ence weak­ness in Septem­ber. The sea­sonal anal­y­sis chart shown here in­di­cates that Septem­ber has tra­di­tion­ally been the worst month for the in­dex on av­er­age over the past 40 years.

The north­ern hemi­sphere sum­mer months (May to Septem­ber) are tra­di­tion­ally rather lack­lus­tre on US mar­kets, with Septem­ber be­ing the one month with con­sis­tently neg­a­tive av­er­age re­turns.

The good news is that the buy­ing weak­ness has ac­tu­ally pro­vided a great op­por­tu­nity for prof­its in the fol­low­ing months. Oc­to­ber, Novem­ber, De­cem­ber and Jan­uary have his­tor­i­cally pro­vided the best four months’ back-to-back per­for­mance.

The his­tor­i­cal monthly per­for­mance sug­gests that the old in­vestors cliché of “sell in May and go away. Buy again on St Ledger Day” ac­tu­ally has some merit. St Ledger Day is the day in Septem­ber when the horse race of that name is run in the UK.

In the past 65 years, the US stock mar­ket has given a re­turn of just 0.3% on av­er­age be­tween May and Oc­to­ber. From Novem­ber to April US mar­kets have re­turned 7.5% on av­er­age.

If one were look­ing to buy into weak­ness in Septem­ber, the S&P500 sup­port zone of about 2,100 looks ap­peal­ing. If that sup­port level were to break to the down­side, then the next area of ma­jor sup­port comes in at the area be­tween 2,040 and 2,060, where the 200-day mov­ing av­er­age comes into play, as do the swing lows from April and May. The next sup­port be­low that is at 2,000, which is the level the mar­ket reached af­ter the Brexit de­ci­sion in late June.

It ap­pears some near-term weak­ness is quite fea­si­ble, but if the sea­son­al­ity pat­tern is any guide, then a buy­ing op­por­tu­nity may be com­ing up soon.

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