Investor Risks as September Begins

Market Optimism and Bullish Positioning

Following the correction in August, bullish positioning has made a strong comeback. However, as September begins, investors face two significant risks. While optimism and bullish positioning are key ingredients for a market on the rise, there are other factors to consider.

As the market rises, investors often chase higher stock prices, leading to a buying spiral. This results in improved market breadth and participation, which further supports price increases. After the decline in August, there has been an improvement in the NYSE advance-decline line and the number of stocks trading above their respective 50-day moving averages (DMA).

However, as prices rise, the number of buyers willing to pay current prices is dwindling. Despite this, investors are becoming increasingly bullish as prices rise. The composite fear/greed gauge, based on market positioning, shows a return to more greed-based levels. While not at extreme levels, investors are becoming increasingly optimistic about higher future prices.

Risks to the Bullish Advance

As we enter September, two primary risks are developing for the bullish advance.

Share Buyback Window Begins To Close

Over the next two months, a key risk for bullish investors is the removal of a critical buyer in the market – corporations. Corporations have made up approximately 100% of net equity purchases since 2000. Without corporate share buybacks, the market would be trading closer to 3000 rather than 5600.

However, these share buybacks also pose short-term risks to the market. As we move past peak share buyback season, the number of buybacks will decline rapidly until early November. As the number of buybacks declines, the market, specifically the stocks conducting buybacks, will have less demand for their stock.

From early September, the window for buybacks will begin to close. By the beginning of October, corporate buying support will be non-existent. This means that the primary buyer of equities will not be available to bid prices.

Presidential Election Concerns

As we enter September and October, a secondary risk increases. Historically, these months have seen stock market declines, especially in years with a Presidential election. The reasons for this trend include uncertainty surrounding election outcomes, concerns about policy changes, and the release of economic data.

Markets dislike uncertainty, and the outcome of a Presidential election is a significant unknown. Investors often become cautious during election years, especially when the race is tight. They worry about potential policy changes impacting taxes, regulations, and government spending. This heightened uncertainty increases market volatility and often results in stock market declines as investors move to safer assets.

Depending on the election outcome, significant policy changes can occur. With the polls very tight, Wall Street may look to lock in gains before the election, fearing that new policies might negatively affect corporate profits via higher tax rates and, potentially, changes to capital gains rates.

Bottom Line

As we head into September, understanding these two risks can help investors navigate a potential increase in volatility, particularly during election years. However, timing such a consolidation or correction is always tricky. It's recommended to maintain risk controls, take profits as needed, rebalance portfolios, and hold slightly higher cash levels. While these actions won't entirely shield portfolios from a near-term decline, they will buffer increased volatility, allowing for more rational and controlled portfolio management decisions.

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