A return to volatility

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

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.