Leave it up to the Federal Reserve to ruin the party. All the major indices that we follow had been posting positive returns for August up until Jerome Powell’s Jackson Hole speech on the morning of August 26th. These comments from the leader of our out-of-touch Fed opened a trap door under the market and led to significant drops by more than 5% over the last four trading days. These trap doors have been a characteristic of the 2022 market, a period within each month where a comment by the Fed or a data point such as inflation leads to a substantial pullback over consecutive days:
These periods of volatility that we have seen so far throughout 2022 are almost the opposite of the 2021 market and is the first period of extended volatility that we have seen since the spring and summer of 2011. Between May and September of 2011, the S&P 500 dropped more than 18% as the market dealt with several issues, including the European Debt Crisis, the US Debt Ceiling & debt downgrade, and lack of Fed support after QE1 was completed. Again, the play that is the market always remains the same; it’s the players that change. In 2022, we have had to deal with inflation, supply chain issues, and a lack of Fed support after QE4 was completed. It remains to be seen if the market can turn around as quickly as it did in 2011.
Turn Back the Clock- 2021 edition
In our September 2021 market outlook, we presented the following comments and data about having positive market history on our side:
For 2021, the S&P 500 Index is up roughly 20%. This is the 15th time since 1950 that the S&P has closed out the first eight months of the year with a gain of greater than 15%. This market performance has traditionally represented a positive market signal for the rest of the year.
In twelve of the previous fourteen years, when the market was up more than 15% through August, the market posted an average return of 7.35% for the remainder of the year. Only the markets of 1986 & 1987 were outliers where market strength was reversed during the final four months of the year. For as bad as the last half of 1987 was, the S&P did end positive on the year.
Looking out even further, this type of market strength has been an indicator of strong stock market returns for the next four years. See chart:
Forward Performance of the S&P 500 When the Index Is Up More Than 15% Through August (Since 1950)
What this means for 2022
While the last four months of 2021 followed the expected trend and closed on a strong note, the action of the S&P 500 from the end of August 2021 to the end of August 2022 has produced one of the few negative return periods from this study. With a -12.55% return over the last year. The 2022 market resembles the markets of 1962, 1988, & 1990 as negative outliers in this study:
Updated Forward Performance Table Including 2021
One essential item to take from this study, after the second year, is the market periods in this study all post positive gains from their inception by an average of 22.37%, which includes the three periods that our current market most closely resembles. Moving forward after the first year of the study, almost all the data is positive in performance.
Mid-term Election Years
We can drill this data down even further when looking at the negative years in 1962 & 1990, both of which were midterm election years:
To start the year, the S&P fell by 28.23% before making its midterm market low in June. Most of the weakness was attributed to the “May Break” of 1962 or the original flash crash, which had investors believing a second great depression was upon them. Surprisingly from the end of August 1962, the S&P went on to average 13.75% over the next three years.
For the first seven months of the year, the S&P was flat, but that quickly changed when Saddam Hussein invaded Kuwait on August 2nd. The rise in oil prices and geo-political uncertainty caused the S&P to drop 17.42% over the next three months before finally making its midterm market low in October 1990. Similar to the market response after the 1962 low, the S&P offers roughly 13% annual returns for the next three years.
While this year has been and will continue to be challenging for some time, this historical data again points to better days. And if the S&P over the next year keeps with the trends of this study, we should assume that by the end of August 2023, the S&P should be trading above 4,522.68.
September to Remember or Forget
Since 1950, September has been the worst month of the market across the board. Although a midterm election year brings slightly better performance, historical monthly returns have consistently been to the downside. Over the last 15 years, September maintained its title as the worst month for the S&P in 2021 with an average -0.84% return, including a -4.76% last September.
The one significant benefit of September’s overall poor performance is that it usually leads to the start of the year-end rally. Below is the Stock Trader’s Almanac STAAC seasonal chart that averages the 1-year seasonal pattern from all years between 1946-2001, the second year or midterm year, the 4-year Presidential Election Cycle, and the Decennial Cycle for the second years of each decade.