Groundhog Day: Will September's Sell-Off Repeat?

Includes: ACWI, ACWV, IOO
by: Russ Koesterich, CFA

Come September, investors might feel as if they are trapped in their own version of Groundhog Day. Last year, the Dow dropped 6% in September. Given the month's consistently negative bias and lingering headline risks, there is a reasonable chance markets will come under pressure again this year.

While investors often pay too much attention to the calendar, September is the notable exception. Looking at data on the Dow Jones Industrial Average, which stretches back to 1896, September has historically been the worst month of the year, with an average return of slightly worse than negative 1%. This is the only month of the year for which the seasonal bias is so great as to be considered statistically significant.

The tendency for markets to fall in September is also evident when you look at the win rate – how often equities move higher. The win rate in September is barely 40%, versus nearly 60% for the other 11-months. Finally, this phenomenon is not limited to the United States. September has historically been the worst month of the year in a number of European markets – including Germany and the United Kingdom, as well as in Japan.

In addition to a negative seasonal bias, there are three other reasons to be concerned about the headline risk to the markets in the coming weeks:

  • On September 12, the German Constitutional Court will rule on the constitutionality of the European Stability Mechanism (ESM). Investors currently expect a favorable ruling, so any other outcome is likely to be disruptive.
  • The Netherlands holds an election, also on September 12. This is risky for markets as the outcome may very well be a fragmented government, which will call into question the commitment of the Dutch to further fiscal integration and their support for the southern European countries.
  • Closer to home, on September 12 the U.S. Federal Reserve will begin two days of deliberation about the economy and monetary policy. Many investors are still expecting, or at least hoping for, an extension of the Fed's quantitative easing program, but there is considerable scope for disappointment should the central bank stand pat.

In addition to headline risk, there has been a growing complacency in global equity markets. This trend is particularly evident when looking at implied volatility, or the VIX Index. In mid-August the VIX went below 15, well below its long-term average. While there are several technical reasons that the VIX is this low, it should still concern investors. A low VIX reading indicates weak demand for put protection, suggesting that investors are not particularly concerned with downside protection. Previous readings in this vicinity – in March of 2012 and the spring of 2011 – coincided with short-term tops.

How should investors position their portfolios? While I still prefer equities over the long-term, this is probably a reasonable time to consider trimming back on positions and looking for instruments that offer the potential for downside protection. One way to achieve this is to re-allocate from a cap-weighted exposure into a minimum volatility fund, or other instruments which tend to have a lower market beta.

For investors looking for global exposure, I like the iShares MSCI ACWI Index Fund (NASDAQ:ACWI), the iShares MSCI All Country World Minimum Volatility Index Fund (NYSEARCA:ACWV), or the iShares S&P Global 100 Index Fund (NYSEARCA:IOO).

Source: Bloomberg

Disclosure: The author is long IOO.

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