Historically, September is the worst month of the year for stocks. This year, that dynamic could be exacerbated by another unusually large Federal Reserve interest rate hike and the doubling of quantitative tightening, all to slow down the economy to fight inflation in an economy that is already slowing.

In a recent research note, Goldman Sachs Asset Management explained how investors are facing “inflection points,” such as macroeconomic changes, adoption of new technologies and a shift in central bank monetary policy; all of which create new investment opportunities but can also make for difficult transition periods for some companies.

“As inflation continues to run high and real wages struggle to keep pace, some companies are already struggling to pass on cost increases to consumers, which may result in a reset of corporate profitability with negative implications for equity prices,” the Goldman report said. “We ideally want to hold companies that can adapt to these new conditions while staying nimble and effectively managing expenses.”

Earnings guidance for the second half of the year is coming down as companies feel pressured by the current environment. Even though we believe our portfolio consists only of high-quality names with strong market share positioning and great balance sheet, we must acknowledge that it is highly likely that the market will continue lower from a losing month of August, and we’re going to experience some pain. However, we see market downturns as opportunities to buy shares of high-quality companies at better valuations. 

Where we are, where we’re going

After falling almost 21% in the first half of 2022 — its worst start to a year since 1970 — the S&P 500 hit a bottom of 3,636 on June 17 and proceeded to rip higher to 4,325 on Aug 16. But for the past two weeks, the index has given up half of that gain. On last Friday especially, the market plunged after Fed chief Jerome Powell warned of “some pain” ahead as monetary policymakers grapple with stubborn inflation.

Now comes September. According to data by Yardeni Research, the S&P 500′s average percent change from 1928 to 2021 has been a loss of 1% in September, the worst of any month. Over that period, September has been lower 51 of those years, the most of any month, averaging a 4.6% decline in those down years. It’s widely thought that investors who come back from summer vacation may readjust their portfolios before the end of the year by selling positions to take some profits. Another explanation has to do with corporate buybacks. Generally speaking, companies are restricted from buying back their own stock two weeks before the end of their quarter. Since many companies are October quarter end, the market loses the support of buybacks starting the last two weeks of September.

September is likely a tough month, but that doesn't mean the rest of the year will be likely tough. 

• Analysis from market technician Larry Williams suggests the market could end the year on a strong note. When comparing the Dow Jones Industrial Average’s 2022 performance with previous years, Williams found that the Dow’s performance in 2014, 1962 and 1891 all showed positive trajectory that resembles 2022′s performance. When the charts are compared, they convey that the rest of the year could end in a rally (see figure below).

• Another key event later this year for investors to watch is the midterm elections, which is expected to change the control of the House and Senate. There tends to be a lot of volatility heading into midterms, which is historically followed by a rally after elections regardless of outcome. According to Yardeni Research, the S&P 500 during midterm years since 1951 tends to be higher 12-months after the elections.

Bottom line

We obviously can’t control the market, but we can control our buying and selling. In June-July, as the market was in a lot of pain, everyone was hating stocks, we held our nose and bought heavily. After almost doubling the performance of the S&P500, we aggressively reduced our positions, selling portions that we bought at lower prices. In this particular downturn, our portfolio declines a little more than half the magnitude of the S&P500. This means we're happily outperforming the index, increasing twice yet declining at half the magnitude.